Investors got a shock when stocks nose-dived at the end of last year. And there’s been talk lately of slowing global economic growth and persistent worries of a recession here in the U.S.
To sleep better at night, you might consider a defined-outcome investment, which enables you to participate in a rising stock market while protecting you from most of the downside risk.
An example of this type of investment is the Defined Preservation 95 Fund from m+ funds.
The Defined Preservation 95 Fund is designed to provide a return equal to that of the SPDR S&P 500 ETF
for a three-year term starting on Oct. 31, 2018, capped at a gain of 27%. At the same time, it offers downside protection of 95% of the invested amount. (The SPDR S&P 500 ETF tracks the performance of the S&P 500 Index
This is a unit investment trust — an investment company that has a fixed portfolio for a limited time, after which the company is liquidated and its unit holders repaid. (Mutual funds are also investment companies, but they are open-ended, meaning they don’t come to an end at any specific time, their portfolios change and they constantly issue new shares and redeem shares.)
The net asset value (NAV) for a unit investment trust or a mutual fund is the market value of the portfolio divided by the number of shares.
M+ funds is headquartered in Darien, Conn., and has about $100 million in assets under management. The firm has been running defined-outcome unit investment trusts since early 2017.
During an interview on Jan. 22, Oscar Loynaz, a partner at m+ funds, said defined-outcome investing is not a new concept, as there are other investments that guarantee returns or principal, such as structured notes or annuities. But these can be expensive and the guaranteed returns may not be attractive. There is also credit risk, because the issuer of an annuity could potentially fail, however unlikely that may be.
Loynaz said m+ funds wanted “to put all these concepts into a 1940 Investment Act fund,” meaning one with shares that individual investors could easily buy and sell, “with fees aligned with competitive products.”
He also contrasted the m+ approach with other ways of lowering investment risk, including low-volatility ETFs.
Loynaz said his firm’s approach is to “take your beta and shape the risk-return around that beta to meet your objectives. Take out the variability. If you want to achieve a certain objective from a risk-return profile, there is a defined outcome that can probably get you there. The market can go up 100% but it can drop 75% as well.”
Shares of unit investment trusts run by m+ funds are not listed on public exchanges. They are available through investment advisers and broker/dealers and have one-time fees of 0.75% of the money that is invested. So the potential returns and principal guarantees don’t include that fee or any other fee charged by the investment adviser or broker/dealer.
Loynaz said the Defined Preservation 95 Fund will probably continue to issue more shares according to investors’ demand for “close to six months” from the starting date, “depending on how the market performs.”
Even though nearly three months have passed since the Defined Preservation 95 Fund was established, investors have not missed out on anything. Through Friday, the SPDR S&P 500 ETF was down 1% from Oct. 31. This means if you had purchased shares of the Defined Preservation 95 Fund at the close on Friday, you would pay less than its initial NAV, meaning your upside potential through Oct. 31, 2021 would be more than 27% and that more than 95% of your investment would be protected.
How it works
The Defined Preservation 95 Fund holds a portfolio of options designed to capture up to 27% of the upside (assuming the SPDR S&P 500 ETF gains that much or more) during the three years, while guaranteeing 95% of the principal. This is different from an annuity, where the issuer is hoping (if it is an equity annuity) that the stock market will perform better than the return being guaranteed. m+ funds makes its money from the 0.75% initial fees.
Loynaz pointed out that the fund has a tax advantage for long-term investors. “All our funds are taxed as long-term capital gains,” provided you hold the shares for at least a year and a day, he said.
Other defined-outcome products
Loynaz explained that because the firm is only running unit investment trusts, there will be a constant flow of new ones being offered and older ones coming to an end. The firm expects to offer one per month. Some are, or will be, customized based on discussions with investment advisers and broker/dealers.
The m+ Preservation strategy isn’t limited to the Defined Preservation 95 Fund. It can vary, with different levels of potential gains and loss guarantees as the fund issues more unit investment trusts.
The firm runs other strategies tailored for varying investment objectives and risk tolerances. They are tied to specific ETFs when new unit investment trusts are offered. These include:
• Balanced 200/10 Fund — Designed to outperform a broad ETF “in a modest positive or a negative price return environment” over a specific period, typically one to three years, up to a stated maximum return level,which might be two times the ETF’s return. The investor is protected from the first 10% of potential loss over that period, beyond which losses are unlimited.
• Enhanced Growth 150 Fund — Designed to outperform a broad ETF in a rising market over a period of one to three years. The maximum gain will be a stated multiple — 1.5 times the ETF’s gain, for example. There is no downside protection.
So there will be plenty of variation in the terms of the unit investment trusts that are offered as the months go buy.
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Source : MTV