Demand for new types of guaranteed products from both users of defined contribution plans and retail investors is booming in Europe.
So far, the demand largely is on retail side, although the scope might grow as many European countries continue to adopt defined contribution plans. Examples include:
Deutsche Gesellschaft fur Wertpapiersparen, the mighty retail arm of Deutsche Bank in Frankfurt, already attracted 6.8 billion deutsche marks (U.S.$3.87 billion) into guaranteed funds since 1991, half in equity funds and half in equity/bond funds.
Robeco Groep, Rotterdam, has pulled in 3 billion guilders ($1.5 billion) for guaranteed funds, primarily from individual investors. But it is developing products geared for the institutional marketplace.
Sinopia Asset Management, Paris, a unit of Credit Commercial de France, has attracted nearly 8 billion francs ($1.35 billion) through its equity-linked guaranteed products.
Banco Santander, Madrid, manages 18 retail guaranteed funds, with total assets of 862.6 billion pesetas ($5.8 billion). This month, the manager hopes to raise another 50 billion pesetas for two new funds.
Gartmore Investment Management P.L.C., London, has pulled in 5 million pounds ($8 million) in the past two quarters since it launched a Controlled Risk U.K. Equity Fund that is targeted at the nascent British defined contribution plans.
Guaranteed products traditionally have been tied to bonds, but there has been a rash of interest in equity-linked products in the past two years. Cautious retail investors with limited experience of equity markets are attracted to the idea of higher returns than bonds, but still wish to protect their capital.
"It's been a booming growth industry. But until recently 95% (of investments have been) in fixed income," explained Frederico Ysart Alcover, a spokesman for Banco Santander. "Only in the last couple of years we've seen equity-linked funds on the market."
In fact, some pension experts think guaranteed products could provide a bridge between traditional defined benefit plans - in which the employer bears the risk - and defined contribution plans, where the onus is shifted to the employee. Guaranteed funds offer more protection, although at the cost of some upside gains.
"Many individuals would like the certainty of a guaranteed return," observed Koen de Ryck, managing director of Pragma Consulting NV in Brussels.
Some think use of the vehicles could go further. Said Donald Duval, director of research at AON Consulting Ltd., London: "What I'm speculating about, although it's very vague at the moment, is that these approaches can act as an intermediate stage between DB, which offers a guarantee, and DC, which does not."
Innovative products developed
In response to this growing demand, investment managers are scrambling to launch products. These vehicles, often involving derivatives, offer a guaranteed minimum investment return or limit the downside risk over a given period of time.
Europe's insurers have been able to offer a guaranteed minimum investment return by placing the bulk of their assets in fixed-income instruments, squirreling away any profits made during the good years and then using this surplus to smooth over the years when performance drops.
But these guaranteed returns have been unspectacular, rarely exceeding 3% or 4% per year. Now, banks and independent money managers are entering the fray with a range of new and innovative funds, investing in both equity and fixed-income instruments and often involving the use of derivatives.
According to Michael Hockings, director of research at Lipper Analytical Services in London, these funds generally take two forms: Contractual guaranteed funds that are underwritten by a parent company or depository, and non-contractual funds, which have a "soft" guarantee that won't necessarily be honored if the fund fails to perform.
"The vast majority of these types of funds are offered by banks and distributed through their banking networks," Mr. Hockings added.
In fact, there were 434 contractual guaranteed funds available in Europe and 248 issued on a non-contractual basis, according to figures released by Lipper last fall. However, since then the market has boomed and current figures are probably much higher.
Dutch demand soaring
In the Netherlands, for example, Robeco is anticipating a huge increase in demand for guaranteed products, according to Roland Devries, its product development manager.
The manager already offers five "click funds" worth more than 3 billion guilders - so-called because they lock in an investor's profits by using put options once a certain performance target is reached - and launched two others earlier this month.
According to Mr. Devries, the funds primarily are bought by Dutch retail investors who hold them for five or six years, although some have been purchased by institutional investors and used for pension purposes. Robeco is working on guaranteed products that are tailor-made for institutional investors and might do something on a pan-European basis at a later stage, he added.
In Germany, meanwhile, DWS, the retail arm of Deutsche Bank, already has 6.8 billion marks in guaranteed funds under management, half in equity funds and half in equity/bond funds combined.
According to Eckhard Bergmann, a spokesman for DWS, the funds primarily are being bought by retail investors who want to invest in equities with a reduced risk.
DWS hedges itself either by using put options on a relevant equity index or by buying a fixed-income portfolio and then buying call options on an equity index. It then guarantees investors that it will pay back at least the net asset value of their investment after the fund's duration - usually three years.
Not everyone, however, believes guaranteed products are the way of the future. In France, for example, where guaranteed products offered through insurance contracts long have been the norm, Jean Echiffre, marketing director at State Street Banque in Paris, repudiates the trend.
"We've always thought that if you had the time to invest in the medium or long-term, then why accept a decrease in your return to buy a guarantee?" he asked. "Over 10 years, the probability that your investment will drop is very small and you can guarantee your investments through diversification and that seems to us to be better."
But most European money managers view guaranteed products as a positive development that opens up exciting, new possibilities. Brussels-based Kredietbank is typical of this new breed. It started offering a range of "click funds" in 1996.
Erwin Schoeters, its head of product development, said the funds often are viewed by investors as a first step away from fixed-income investing and into equities. They also have the advantage of being highly flexible as savings vehicles, he added.
Budding U.K. interest
In fact, that's exactly what's happening in the United Kingdom, where several fund managers recently have launched guaranteed funds specifically targeted at users of defined contribution plans.
"If you provide a DC product range, we're of the opinion that you have to offer a protected or guaranteed alternative in order to increase your investment possibilities," argued Douglas Shaw, a derivatives fund manager at Gartmore.
Mr. Shaw said guaranteed products within a defined contribution structure have two uses.
First, for those nearing retirement, they offer an alternative to going into cash or bonds.
Second, they can act as a bridge between cash or fixed income and equities, thus avoiding "the reckless conservatism" demonstrated by some defined contribution investors in the United States.
Gartmore's Controlled Risk U.K. Equity Fund, launched in March, has risen 19.28% in its first two quarters, while the U.K.'s FTSE 100 share index has risen 19.9%.
"So even though you've paid for it, you're within spitting distance of the FTSE," Mr. Shaw said. "So the cost has been hardly anything."
He added that should the fund fail to live up to its promise of guaranteeing a minimum level of return of -2.5% in one quarter, then Gartmore's ultimate owner, National Westminster Bank, would cover the shortfall.
Gartmore is marketing the product in the United Kingdom only. However, there are plans to construct a similar product for global equities and market it on an international basis.