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While investors seek safety months into the current prolonged market downturn, many are also looking at ways to participate in the eventual rebound while protecting their investments.
Enter market-linked guaranteed investment certificates (GICs), which provide the safe-haven status of a GIC that so many want in today’s tumult but can deliver equities-like gains when stocks eventually pull out of their malaise.
“If you look, historically, back to the tech bubble and then [the global financial crisis in] 2008, within 12 to 36 months, investors made their money back and then had more upside,” says Kaif Lalani, financial advisor with the Hudson Wealth Management Group at Raymond James Ltd. in Toronto. “This gives you the opportunity to make your money back but still protect your downside.”
Few financial products have the backing of the Canadian Deposit Insurance Corp. – and GICs and savings accounts are among them. Yet, there’s only one product that can offer stock returns while protecting your principal – market-linked GICs.
Jeanette Power, senior wealth advisor with the Power Investment Team at CIBC Wood Gundy in Mississauga, says she wouldn’t have recommended these products three or four years ago simply because interest rates were low and they’re tied to the equity market.
“Many times, clients were willing to take the risk” of investing directly in equities, she says. “The market’s changed. Everyone is asking about GICs, or different structured notes, which is essentially what a market-linked GIC is.”
Similar to other big Canadian institutions and brokerages, CIBC Wood Gundy offers clients more than a dozen market-linked GICs. The notes can track an entire index such as the S&P/TSX Composite Index or cover a select basket of stocks in a given sector or theme, such as banks or pipelines. By using options and other instruments, they guarantee an investor’s principal in the event of a downturn.
“We’re in an environment right now that certainly makes them more attractive,” Ms. Power says.
Market-linked GICs carry similar terms to conventional GICs with two- and three-year duration notes being the most popular. Others can extend out into six or even eight-year durations.
Which products can pack a ‘powerful punch’
John De Goey, portfolio manager at Wellington-Altus Private Wealth Inc. in Toronto, says advisors need to be very selective about how their market-linked notes are structured and where they fit into a client’s overall portfolio.
“They come in many different shapes and sizes,” he says. While he’s not a fan of broadly linked GICs tied to entire indexes – what he calls “mutual funds on training wheels” – he says that linked GICs that target specific sectors or themes can add a powerful punch to a client’s holdings.
“I am a proponent of some of these products,” he says.
Mr. De Goey likes what are sometimes termed as “look back” notes. The market-linked products track a specific basket of stocks and will use the lowest valuation within a certain window of time as their benchmark low. However much the basket of securities rises off that point represents the notes’ return.
Mr. De Goey offers one recent and notable example that paid off handsomely.
In January, 2020, he created a linked GIC for his clients that tracked a custom index he created of low-volatility Toronto Stock Exchange-listed stocks, comprised of big Canadian blue chips. By March, as the market responded to the pandemic’s arrival in North America, even that index had experienced stomach-churning declines. March, of course, was the pandemic trough. By mid-2021, as markets recovered – and then some – his custom notes with full principal protection were up 48 per cent.
“The experience as you might imagine was fortuitous,” he says.
Issuer keeps dividends and overall return is capped
While there’s typically no fee to purchase a market-linked GIC, there’s often compensation for the issuer built in.
Mr. De Goey uses National Bank Financial to build the custom market-linked GICs. A standard practice is for the issuer who created the note to keep the dividends of the underlying stocks as a form of payment. Clients won’t receive that income.
“That’s their rationale [for offering the linked GIC], and that’s the win for them,” he says.
The issuer can also be compensated by sharing in the return on the notes, says Jillian Bryan, senior investment advisor and senior portfolio manager at TD Wealth Private Investment Advice in Vancouver.
Many market-linked GICs now offer a minimum return, like the TD Canadian Bank GIC three-year note. It promises to pay a minimum of 2 per cent annually, yet the total return is capped at a cumulative 15 per cent. The issuer then keeps any additional return.
“You get a base return, which is nice, though your potential overall return does have a ceiling,” Ms. Bryan says.
Gains in market-linked GICs are also taxed as interest income, or a higher rate than capital gains realized in an investment such as a stock or mutual fund, unless they are in a tax-sheltered registered plan such as a tax-free savings account or registered retirement savings plan.
Furthermore, Mr. De Goey says these products shouldn’t be considered a stock-like asset within an overall portfolio. Despite having equity exposure, it’s still a low-risk product.
“If it’s playing a role in your equity holdings, it’s not worth it,” he says. “If it’s playing a role in your fixed income, it’s probably worth it.”
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