Disclosures for managed-payout mutual funds — launched in the last year to help retirees manage income — must make it clear that unlike annuities, such funds do not guarantee income.
That point was made by Vanguard senior counsel Natalie Bej, who spoke Nov. 14 at a conference in Washington on life insurance products sponsored by the Philadelphia-based American Law Institute-American Bar Association Committee on Continuing Professional Education.
"With this product, I think you have to be very clear it's not guaranteed income," said Ms. Bej, who is senior counsel of securities regulation at
The Vanguard Group Inc. in Malvern, Pa.
"Even if your capital grows, it might not be sufficient to cover the distributions. Some of the payments may come from principal, so it could be a return of capital," she told about 200 attendees at the conference.
Both payments and principal can go up or down, and investors need to be made aware of the fact that if they redeem shares it will affect their next monthly payment, since payments are based on the balance in the fund, Ms. Bej said.
Managed-payout funds were introduced into the market in October 2007 by, among others,
Fidelity Investments, Vanguard, The
Charles Schwab Corp., OppenheimerFunds Inc., Russell Investments, and DWS Investments.
Driving the market is "the shift from retirement savings to retirement spending [with] more retirees depending on retirement accounts that they fund and manage themselves," Ms. Bej said.
But she added that the funds "came out in a very challenging market," which makes marketing them difficult.
Many retirees who are receiving
Social Security and pensions, or who may still be working and are looking for supplemental income for travel or non-essential expenses, could be good candidates for managed-payout funds, Ms. Bej said.
"The idea is really to have a mutual fund that can grow a nest egg while generating a steady stream of monthly income. And it's liquid, so that you can redeem at any time to retrieve your principal investment and not have it locked up in the form of some sort of annuity," Ms. Bej said.
Managed-payout funds somewhat resemble target date funds in that there is a predetermined asset allocation strategy that gradually shifts from stocks to bonds as the target date approaches, she said. However, managed-payout funds are very different from target date funds in that rather than build toward a large payout at maturity, they gradually return funds to shareholders through monthly payments, Ms. Bej said.
Unlike some other managed- payout funds, Vanguard's products, which were first sold in May, do not shift from an aggressive to a conservative allocation over time, and they do not have set maturity dates. Vanguard's products pursue an actively managed asset allocation strategy, and they are not fixed-term funds with an expiration date, Ms. Bej said.
Vanguard's three funds are managed similarly to endowments, she said. "An endowment is not trying to beat the market or beat other endowments. It's just trying to make enough in gains to cover the institutional liability. The goal of the managed-payout funds is not to beat the stock market. It's not to beat out its competitors but to earn enough under different market conditions to support these monthly payouts, to cover a shareholder's need for a certain level of retirement income or for leisure or travel expenses," Ms. Bej said.
In addition, the goal of such funds is to dampen market volatility by investing in various asset classes and having some exposure to absolute-return investments, she said.
Other speakers on the panel asked whether managed-payout funds are likely to turn to hedging techniques in light of current volatile market conditions.
"In light of the recent market crisis, has that prompted some rethinking in terms of the underlying investments or the strategies, perhaps to incorporate more hedging techniques to accommodate or account for that volatility?" asked Richard Choi, a partner in Washington-based law firm Jorden Burt LLP.
"There are different lines of opinion in terms of the use of alternatives, and people are watching it very closely," Ms. Bej replied. "The whole swaps market is under review just in terms of how that's going to be regulated, how it's going to be operated."
There is a market for principal-protected funds, Ms. Bej said. "But you have to realize that it comes at a price. So if you're going to have that sort of guarantee ... that's going to be reflected in your expense ratio."
E-mail Sara Hansard at [email protected].
