Guaranteed Target Date Funds sound too good to be true

[Rillapalooza]

Hey folks, here's my situation. These are how I'm currently allocated in my companys offered plan:
40% TDAM US Market Index Fund 0.36% MER
20% TDAM Canadian Equity Index Fund 0.35%
20% TDAM International Equity Index Fund 0.47%
20% TDAM Canadian Bond Index Fund 0.35%

The company also offers target date funds from 2015-2045 and the MER's range from 0.69-0.86% in those funds. However the TDF's are guarenteed to pay the highest monthly closing price over the life of the fund as long as you leave the money in it until maturity. Does this not seem too good to be true?

From the website "The objective of the Fund is to provide investors with a
portfolio that is matched to the time horizon of their
investment milestone. As the fund's maturity date (June
30) approaches, a greater proportion of assets is
invested in bonds with the objective that the risk of the
overall portfolio declines. The potential for capital
appreciation is combined with protection from downside
market risk through a guaranteed value at maturity. If
held to maturity, the investor will receive the highest
month-end unit value achieved over the life of the fund,
as guaranteed by Sun Life Assurance Company of
Canada."

It seems to me the risk is very low in these funds or am I missing something?

Thanks for any insight in advance.

[seattlecyclone]

I don't know the details of these funds. They will be transitioning to mostly bonds before the end date. The more bonds in the portfolio, the less likely the value will go down in nominal dollars. Even if there happens to be a stock market crash when the portfolio is mostly stocks, it's likely that the slow growth offered by the bonds over time will bring the value back up to its peak. The combination of these factors means they're unlikely to need to pay out on the guarantee at all. But even if they do, they're able to take that relatively high expense ratio, invest it, and use the proceeds to manage the risk of the guarantee coming into play.

[MDM]

If held to maturity, the investor will receive the highest month-end unit value achieved over the life of the fund, as guaranteed by Sun Life Assurance Company of Canada."

It seems to me the risk is very low in these funds or am I missing something?

As seattlecyclone implies, the devil could be in the details.  How exactly is a "month-end unit value" defined and calculated?  It "sounds too good to be true"....

[Rillapalooza]

@MDM @seattlecyclone Thanks for the replies, here the definition of the month end value: "The guaranteed maturity unit value reflects the fund's highest month-end unit value to date. While the fund is valued each business day and its unit value does fluctuate, the maturity unit value is only affected if the unit value on the last day of each month exceeds the current maturity unit value. You will receive the maturity unit value only upon the fund's maturity date, providing you still own units in the fund on the maturity date. The maturity unit value is guaranteed by the Sun Life Assurance Company of Canada. If the units are sold prior to the fund's maturity date, the guarantee does not apply and you will receive an amount determined by multiplying the number of units withdrawn by the current fund unit value."

As @seattlecyclone implied the fund allocation shifts from a percentage of Sunlifes Global Market Index fund to a variety of bonds. At the moment most of the funds are slightly less than their guaranteed month end value, eg. SLF 2035 Milestone today 22.1863 guarenteed is 22.6622.

Annuallized Returns:
fund        1yr          3yr         5yr
2015       1.2%        1.6         2.9
2020        8.6           5.5         7.2
2025        16.5         8.9         10.6
2030        20.7         11.4       12.1
2035        23            13.1        13.1
2040         25.1         14.1       13.7
2045        26.3          14.6         -

My thinking is I'll keep contributing into the index funds that I referenced in the first post but I have some RRSP money that I plan on moving from a different institution and might put a lump sum into a few of those target date funds. I'm 34, plan on retiring in 10 years so something like $15000 into each of 2025-2035 purely to manage risk.

[MDM]

As s.c. speculated, it appears the low risk comes along with low returns.  E.g. see http://quote.morningstar.ca/quicktakes/fund/f_ca.aspx?t=F00000JTGQ&region=can&culture=en-CA.  Also note the 2.9% annualized 5 year return for the 2015 fund.

Looking closer at the 2035 fund (same link as above), it currently holds 32% in cash - the ultimate low risk (of losing nominal value), low return investment vehicle.  You can probably hold cash yourself for less than a 2.27% expense ratio....

[Rillapalooza]

@MDM , that's not quite the same fund, the one I'm offered is SLF 2035 Segregated Fund, it's currently 38% MCI World Index Fund and 62% bonds with a fund management fee of 0.84%. Thanks again for the input.

[Rillapalooza]

https://grssl.morningstar.ca/globalhome/quicktakes/Fund_Performance.asp?fundid=76207

[James]

So you give up performance by increasing bond allocation, you give up returns due to higher cost, and in return you get an insurance aspect that protects you from a tiny fraction of a risk. Sure, that insurance has value, but not the amount of value you would be paying in the lost performance and higher cost. I would skip it.


We know how the fund offers the guarantee, they just pay an insurance company to do the actuary math, and then insure them for that risk. So we know the odds are against you, the insurance company wouldn't offer that insurance without knowing they will make money. If the insurance you get from that fund was valid insurance to buy, why don't we all go out and get that insurance? The actuaries aren't hard to figure out the risk, and insurance companies would love the business. The reason is it's not worth much, and you wouldn't buy buying it except that you see it as a benefit without much cost. But if you actually did the math on decreased returns and added costs, you likely wouldn't be spending the money on that insurance by using those funds. It just feels free or cheap, but it's not.