So far in 2006, more than half of fund managers have failed to beat the market.In the first half of the year, the S&P 500 stock index has outperformed 58.2% of large-cap funds, while the S&P MidCap 400 index has outperformed 61.3% of mid-cap funds, and the S&P SmallCap 600 index beat 68.1% of small-cap funds. So if professional fund managers can't even top the market, how are you supposed to manage your retirement-plan investing? Whether your retirement fund comes from your company's 401(k) plan or your own IRA, your retirement financial success depends on the decisions you make today. It's enough to paralyze you with fear -- or at least make you run for the safe cover of market funds or stable value funds. But for those with 10 years or more to go in the workforce and probably an additional 25 to 30 years to live in retirement, those "safe" choices are probably the most risky decisions to make. Even moderate inflation will erode the interest earned, and your money certainly isn't working for you in any meaningful way. Recognizing that aspect of human nature called "reckless conservatism," Prudential Retirement recently has launched a series of products called Capital Guarantee funds designed with an impressive promise: If you hold your fund until its maturity date, you will receive the highest daily value of your fund investment during that holding period -- even if the market subsequently declines. To put it another way, if your fund account value rises for a few years, but then is devastated by a bear market just before the fund matures (in a year designated to be closest to your planned retirement), you'll still get the full value of the fund at its highest point in the cycle.
Very simply, this investment takes away the risk -- and the fear -- of loss without becoming overly conservative. Three huge questions jump immediately to mind: How can they do it? It's done through sophisticated money management and an even more sophisticated use of hedging techniques. Depending on maturity date, the fund units invest in equity and debt securities, and also use Treasury bills, zero-coupon government bonds, as well as stock-index futures and options to manage risk and maintain the promised guarantee. Who guarantees this promise? The ending-value promise is backed by the issuing company, Prudential Retirement Insurance and Annuity, a unit of Prudential Financial ( PRU). Prudential Financial has assets of more than half a trillion dollars. How much does it cost? The annual cost is a surprisingly moderate 117 to 127 basis points, depending on the size and complexity of the retirement plan which utilizes these Prudential funds. That is less than many poorly managed mutual funds manage to charge customers, though the expense ratio is significantly higher than targeted funds offered by Fidelity or Vanguard. You do pay more for the guarantee. So, with those basic questions answered, let's move on to how these Capital Guarantee fund units work within a company retirement plan. The plan starts with four different funds with target maturity dates of 2010, 2015, 2020 and 2025. Each is structured as a professionally managed mix of equity and fixed-income investments. As with most target-date funds, the shorter-term funds are managed more conservatively. The funds are liquid -- meaning you can also sell any day at the current net unit value. But the idea is to hold them to maturity. If you sell before the maturity date of your units, you void the guarantee that it will be worth its highest lifetime value. The actual fund management is done by Trajectory Asset Management, an investment advisor that specializes in quantitative investment strategies. Trajectory has applied for a financial patent on this investment approach. The firm rebalances the funds at least once a day, and sometimes more often in active markets, according to its model.
Like the Prudential Capital Guarantee funds, the High Watermark funds use Treasury bills, government zero-coupon bonds, and S&P futures and options to both create investment return and mitigate risk. The longer-dated funds are managed more aggressively, but the promised high-value guarantees are the same. SunAmerica Asset Management oversees the investment process, and the return promises are guaranteed by Prudential Global Funding. Morningstar analyst Eric Jacobson notes that firms including Merrill Lynch, Oppenheimer and AIG have previously offered various sorts of guarantee promises on more conservative funds and warns that if the fund invests too cautiously, it's not worth paying for the guarantee. After all, an extremely conservative fund won't have much downside from its current value anyway. Prudential says its new series "generates up market participation with downside protection."
At the very least, these funds will be a worthwhile investment if they help investors understand the importance of equity returns in their retirement investments and give them courage to access those returns. And that's The Savage Truth.