BAY STREET-Investor fear fuels market-linked GIC sales
* Historically low Canadian interest rates heat up sales
* Product protects principal, offers some market upside
* Some financial advisors are critical
TORONTO, March 11 (Reuters) - With interest rates low and bitter memories of falling stocks fresh in their minds, Canadian investors are increasingly looking to market-linked GICs, a product that protects their principal while offering upside possibilities.
Sales of Guaranteed Investment Certificates (GICs) linked to equities performance rose to a record C$32 billion ($32.36 billion) in 2011, up 13.7 percent from 2010, according to a study by research firm Investor Economics.
This is just a fraction of Canada's C$450 billion GIC market. But fresh flows into traditional fixed-rate GICs, once a staple investment for risk-averse retirees, have all but dried up as investors take a hard look at their ultra-low returns.
"In a context where other GICs are not growing at all or are declining, this growth is quite significant," said Carlos Cardone, a consultant at Investor Economics, who predicts further sales growth as asset managers come up with new variations.
The 2011 growth is on the back of an 8.8 percent annual rise in 2010, making market-linked GICs one of two go-to products - along with premium savings accounts - for conservative investors looking to guarantee principal and enhance returns.
"This is exclusively driven by the level of rates. Somebody goes to the branch and finds out what the interest rate is, and in many cases these GICs are not renewed," Cardone said.
As just one example, an investor looking to put C$10,000 into a non-cashable two-year GIC with compound annual interest can expect a return of about 1.30 percent at most of Canada's big banks. Lock the money in for four years, and the interest rate rises to just 1.6 percent.
Those returns don't even match the 2 percent inflation target of the Bank of Canada, which is expected to keep its main policy rate at 1 percent until next year.
Domenic Gallippi, head of term investments at Bank of Montreal, has seen the rise in popularity of market-linked GICs first-hand.
"A lot of our clients know they need the additional juice that comes out of the equity markets but they are still fearful - especially with what happened in the last few years," Gallippi said.
Like its competitors, BMO, Canada's fourth-largest bank, offers a growing list of market-linked GICs. While there is no fee to purchase a GIC, banks can profit handsomely in a rising market. Investors get to keep only a portion of the market's gain, with the bank pocketing the rest.
Canadian banks also see the product as a key tool in retaining low-cost deposits and clients.
While it is impossible to know whether a market-linked GIC bought today will do better than the traditional version, a survey of past performances shows how the ups and downs of recent financial markets have played out.
BMO's two-year GIC linked to 10 blue chip stocks returned 2.02 percent per year upon maturity last month. Their four-year "Growth" GIC linked to 15 blue chip stocks returned 10 percent a year at maturity this month.
Returns during market downturns are not as pretty. BMO's "Return Enhancing" two-year GIC linked to 10 blue chip stocks returned the guaranteed minimum of 1.5 percent per year in early 2009. And its one-year GIC linked to 10 blue chip stocks returned only its guaranteed minimum of 0.2 percent upon maturity this month.
BEWARE INFLATION AND TAXES
With every major bank and many others offering a variety of GICs tied to everything from broad equity markets to specific stocks, investors have plenty of options to choose from.
But investment advisors caution the simple appeal and guaranteed safety of principal may mask the downside of a product that gives investors only a portion of market gains and next to nothing at all when markets slide.
As a result, the investment may not even begin to keep pace with inflation.
Brian Burlacoff, a financial advisor at Sun Life Financial, said a properly balanced portfolio can mimic the safety of a GIC by including a product such as a corporate bond mutual fund. Another part of the portfolio with more aggressive equity market exposure can then capture market gains.
The other downside is that gains in a market-linked GIC are taxed as interest income - a higher rate than capital gains realized in an investment like a mutual fund - unless they are in a registered plan sheltered from tax until withdrawal.
Still, Burlacoff has sold market-linked GICs to investors who want the simplicity and safety of a GIC, an age-old product that anyone can understand.
"It is a very simple solution for somebody who may want exposure to equities but are worried about preservation of their capital," he said.
BMO's Gallippi said critics of market-linked GICs who argue investors could get equal or better returns with more direct investments don't understand the target audience.
"These products not geared to the type of client that has the stomach to invest directly in the marketplace on their own," he said.
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