index fund that never goes down ?

[JohnEyles]

So this guy, evidently a financial advisor of some sort, friend of a friend,
was telling about this index fund that follows an index, let's say the
S&P500. The fund goes up when the S&P goes up, but when the S&P
goes down, the fund stays put. Sounds way too good to be true, the
only caveat being that "if the S&P goes up 15%, then fund only goes
up 12%". I asked what this fund is called, and he said "oh, Fidelity,
etc all the major companies have one".

Tempting to write him off as moron or a shyster, but I don't think he's
either, just perhaps a very poor explainer. Any idea what this guy may
have been trying to describe ?!?

[ERD50]

I've heard of them, but can't think of a name either.

So, in this example, they cap the gains. In addition, they probably don't pay the S&P dividends, so that is skimming another ~ 1.4% off the top. And there would be some expense ratios. Something tells me these also are not offered as no-load funds, either. Add it up and it ain't peanuts.

It would be interesting to research a few of these. I'm not sure exactly how they can protect themselves from an extended down market. Maybe after all the skims, they can actually afford to 100% hedge their position against a loss greater than X%? You could buy protective puts with the money I guess. Some strategy like that would probably work. I'm pretty sure they include some hefty back-end fees to help assure you keep your money in for a minimum amount of time. That probably helps them to purchase the correct amount/time for the puts. Maybe the whole thing is a derivative based combo of buying calls and puts on the S&P?

Probably not that hard to do yourself, for less money. We could probably construct one right here (but not until after my AM coffee kicks in).

-ERD50

[retire@40]

Could it be he was talking about the high water mark funds like this one?

http://www.sunamericafunds.com/sun.n...funds?OpenForm

[Texas Proud]

A bank I worked at offered on of these way back in the 80s...

Look for a fund called a Bull and Bear...

What they did was only give you 60% of the gain, but your account did not lose money... I think it also took all gains until it got back to where your account would start to have lost... (I think with a small interest component to keep you)..

So, if the market went down 10%, you did not lose 10%... but, when the market came back to the pre-loss level, you did not make that 10 plus% gain (or the 6 plus% in this case)... or maybe you did.... can't remember...

[LOL!]

equity-indexed annuity
It will cost you lots of money and give your sales person lots of your money.
Tread very, very carefully or not at all. You have been warned:

http://www.sec.gov/investor/pubs/equityidxannuity.htm
http://www.fpanet.org/member/press/r...ityindexed.cfm
http://www.fpanet.org/journal/articl...p0104-art8.cfm
[Edit to add:]
http://www.nasd.com/InvestorInformat...urceNodeId=451

[LOL!]

One more thing, you do not want to just match the index because usually that does not include re-invested dividends. The dividends don't go to you. Question for you: What is the return of the S&P500 from 1970 (or pick your year) to today with divdends reinvested? Without dividends reinvested?

[kaneohe]

Equity Indexed Annuities (EIA)

http://www.sec.gov/investor/pubs/equityidxannuity.htm

You can google for them and find another link to an NASD writeup.

I'm sure these have been discussed on this forum before so a search would probably produce more info. Lots of fine print to read in the contracts---watch out for high costs, ability of the issuer to change the terms after purchase (beyond the variable rates due to market changes, sometimes they can even change the participation rates or maybe even caps), and terms may change if you don't annuitize the contract. Best to go very slowly.

[justin]

I saw an offering of this type of product from my local credit union. You get the SP500 return, up to 12% per year. If the SP500 goes down, you don't lose any money.

Here's the catch: your gains are limited to 3% max PER QUARTER. In other words, if we had 10% gains in Q1, 2% gains in Q2, -5% gains in Q3 and 1% gains in Q4, you would get a 6% increase after one year.

Not a horrible deal. Over the last 10 years, you would have gotten these approximate annual returns starting w/ 2006 and going back:
2006: 9%
5.37
5.34
8.1
3
6
1.75
9
8.79
1997: 10.47%

The straight SP500 returns (VFINX):
2006: 14.99%
4.79
10.64
26.92
-22.02
-10.15
-9.11
20.69
28.64
1997: 30.36

8.1% avg annual return for straight SP500, versus 6.6% avg annual return for the risk-hedged fund.

I didn't investigate the risk-hedged fund for fee structure, but my CU is usually good about getting good deals for its members (they offer vanguard mutual funds, for example). I'm assuming the risk-hedged fund's promised returns are net after fees.

I did a quick run of 50/50 mix of SP500 and short term bonds yielding 5.5%, and it beat out the risk-hedged fund by a little under a percent per year, with more volatility (down years during the 2000-2002 period).

[ERD50]

Quote:

Originally Posted by justin I did a quick run of 50/50 mix of SP500 and short term bonds yielding 5.5%, and it beat out the risk-hedged fund by a little under a percent per year, with more volatility (down years during the 2000-2002 period).

Thanks justin, good analysis.

I like the 50/50 comparison. I think any of us could put together a similar strategy for less than what they charge for these things. The fund companies do have access to products that the small investor can't get to, but none of them can violate the laws of economics. I think any efficiencies that they can gain get eaten up by expenses and their profits. Nothing left for us little guys.

-ERD50

[justin]

Quote:

Originally Posted by ERD50 I like the 50/50 comparison. I think any of us could put together a similar strategy for less than what they charge for these things. The fund companies do have access to products that the small investor can't get to, but none of them can violate the laws of economics. I think any efficiencies that they can gain get eaten up by expenses and their profits. Nothing left for us little guys.

A good balanced fund would probably get you superior returns versus a risk-hedged product with a slight increase in volatility - I'm thinking Wellesley/Wellington, or Lifestrategy conservative/moderate growth, or something similar. Bottom line remains - there's no such thing as a free lunch.

[ERD50]

Quote:

Originally Posted by retire@40 Could it be he was talking about the high water mark funds like this one? http://www.sunamericafunds.com/sun.n...funds?OpenForm

I glanced, it's is a little different. They will pay the highest point of the S&P over the selected period, 2010, 2015, or 2020 (hence, the 'high watermark' name). Lots of fine print that I didn't bother to read.

But, in general, all they need to do is to buy puts at the target date against the price of the S&P when you deposit your $. Then they are guaranteed to be able to give you that price at the target date. Whenever the S&P hits a new high, they just trade in their puts for a new strike price.

I'd bet that all the fine print means they have a lot more flexibility than this, and can do it w/o a 100% hedge. I can see where these sound attractive to people, but once again, there can be no free lunch - you get that peak at a price.

-ERD50

[LOL!]

Quote:

Originally Posted by justin The straight SP500 returns (VFINX): ... 8.1% avg annual return for straight SP500, versus 6.6% avg annual return for the risk-hedged fund.

VFINX returns are with dividends reinvested. The EIA probably does not have dividends going to you -- they go to the folks you bought the EIA from. Can you do the S&P500 return without dividends reinvested for comparison?

[FinanceDude]

Yup.............sounds like an EIA to me..............

There are a lot of "hybrid" investment products that banks have dreamed up. When I worked at Chase, there was a unique product that Chase Private Bank used for their clients. It involved orginating internal "notes" which were composed of baskets of international currencies.

Back in 2003, they were guaranteeing a return of 6% for 6 months, and 10% for a year. Chase was putting the principal guarantee on them, and no doubt arbitraging the risk. However, if the "note" made 20% or LOST 20%, you would "only" get the 6% or 10%...............

[justin]

Quote:

Originally Posted by LOL! VFINX returns are with dividends reinvested. The EIA probably does not have dividends going to you -- they go to the folks you bought the EIA from. Can you do the S&P500 return without dividends reinvested for comparison?

I already did in my original post. To git er done quick and dirty, I simply took out 0.5% return per quarter from the VFINX returns before calculating the returns for the EIA/risk-hedged product.

[dex]

I think these types of funds are more common in Europe. I think they are call guaranteed investment trusts.

[FIRE'd@51]

IMHO, this is the simplest way to think about these things. If you were to buy a one-year Treasury bill (which sells at a discount) and invest the discount in call options on the S&P 500, worst case you get your principal back when the T-bill matures. If the S&P 500 goes up, you participate in the increase through the call options. However, it turns out that you don't participate 100% in the increase because the discount is not big enough to buy the equivalent exposure in the S&P 500.

So to increase exposure, banks and brokers have created a myriad of variations. The simplest is the basic structure I described above but with a longer time horizon, e.g. 5 years. This way you get more participation in the upside, but it's not a free lunch. Yes, worst case is that you will get your money back in 5 years, but with 0% return, so you will have tied your money up for 5-years with no return (not even the dividends). That is the cost of the insurance.

[ERD50]

Quote:

Originally Posted by FIRE'd@51 IMHO, this is the simplest way to think about these things. If you were to buy a one-year Treasury bill (which sells at a discount) and invest the discount in call options on the S&P 500, worst case you get your principal back when the T-bill matures. If the S&P 500 goes up, you participate in the increase through the call options. However, it turns out that you don't participate 100% in the increase because the discount is not big enough to buy the equivalent exposure in the S&P 500.

I like that view. I just ran some very rough, back-of-the envelope (literally) numbers based on SPY @ 141 and the DEC 07 and DEC 08 141 calls. You could probably capture about 65 to 85% (I said it was rough) of the upside of the S&P with that approach.

But, better yet, your example makes it clear that you are giving up that T-bill yield (~4.5%) just to say, "I didn't lose any money this year' in a down market. One would also 'lose' (relative to t-bill) in any year the market return was below t-bill returns.

Worth noodling over for a portion of the portfolio?

-ERD50

[JohnEyles]

Can you explain how one determines the price for a call, for say the S&P500 ?
The quote at yahoo-finance seems to be the value, but I can't see how much you
pay for it. Sorry to be a dumb-ass, calls are new to me.

[FIRE'd@51]

Quote:

Originally Posted by RustyShackleford Can you explain how one determines the price for a call, for say the S&P500 ? The quote at yahoo-finance seems to be the value, but I can't see how much you pay for it. Sorry to be a dumb-ass, calls are new to me.

Multiply the option price by 100 (it is on 100 shares). So with the S&P 500 at 1400, one option (call or put) would be on 100 x 1400 = $140,000 of notional value for the S&P 500 (100 shares @ 1400 per share). Specifications for the contracts can be found here:

http://cboe.com/Products/indexopts/spx_spec.aspx

Note that these options are cash-settled and are "European" style (can only be exercised at expiration).

[JohnEyles]

When I check options for SPY, for example Sept '07 expire,
I see two listed at each strike price, for example at 141.0 I see
SFBIK.X and RQQIK.X. Their prices are fairly different and it's
tough to tell the difference. One European style and the other
not ? Thanks !