Dateline: NEW YORKStung by a three-year bear market, many investors are turning to mutual funds that promise they won't lose money. But financial advisers caution the principal-protected funds are loaded with expenses and restrictions that could unduly hurt returns.
These funds come with insurance policies that guarantee the principal, typically after five or more years, minus expenses. Investors are assured of no losses in a downturn, while they can reap gains if the market recovers.
Investors have responded, pushing the funds' net assets to $9.1 billion at the end of January from $3.95 billion a year earlier, according to fund tracker Lipper Inc. Virtually unheard of five years ago, the fund are now managed by firms such as ING, Merrill Lynch and Salomon Smith Barney.
But advisers say principal-protected funds, which are now concentrated in bonds, don't make a lot of sense at a time many believe stocks can only go up, and bonds down, in coming years. They say investors can achieve better results at a lower cost by maintaining a diversified portfolio and using a buy-and-hold strategy.
"It's a feel-good product, but when the market comes back, then somebody that's not paying for that extra feel-good benefit ideally should see a much more positive response in their portfolio," said George F. Leupold Jr., a certified financial planner in Cherry Hill, N.J.
Principal-protected funds generally buy bonds when the market is falling, which is why they're currently heavy with bonds. They shift to stocks after an upturn, so they tend to lag in performance because they're late into the recovering market.
Still, investors who got into principal-protected funds a while ago benefited in the three-year bear market.
One-year returns for ING's 11 principal-protected funds, for example, ranged from 1.47 percent to 6.33 percent through February, according to fund tracker Morningstar Inc.
In contrast, the Standard & Poor's 500 stock index lost 24 percent, and most money market funds are now paying yields of 1 percent or less, with no guarantee of the principal.
Mark Wilson, a certified financial planner in Newport Beach, Calif., said many investors have been calling to ask about these funds much like they did with Internet funds during the tech boom.
"The markets are down so significantly and people are so gun shy, the return guarantee sounds really, really attractive right now," he said.
But he generally advises against them, noting the restrictions can be complex. The funds are typically sold during an offering period that lasts several months. Afterward, investors must reinvest their dividends and distributions but can't otherwise add to the investment.
If money is withdrawn before the end of the holding period, typically five years or more, investors lose the guarantee on their principal and may have to pay penalties.
Expenses also can be high. The insurance may cost an additional 0.40 percent of total assets, often pushing the expense ratio up to 2.25 percent each year, compared to the 1.47 percent for the average domestic stock fund, according to Morningstar.
And the funds are generally sold through brokers and thus come with additional sales charges of 5 percent.
"You could have a diversified portfolio of stocks and bonds that achieves the same effect at a cheaper cost," said Kathleen Day, a certified financial planner in Miami, Fla.
Financial advisers say the funds might be worthwhile for conservative investors with little tolerance for stock volatility or those who are saving for a specific reason, such as a child going to college in five years, and want their principal protected.
But in many cases, they add, investing in these funds may prove to be an ill-advised reaction to the market downturn.
"These funds are almost entirely sold through brokers, and a lot of people are scared into them," said Jeff Tjornehoj, research analyst at Lipper. "Make sure you're not getting sold on this."
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On the Net:
www.ing.com/us
www.lipperweb.com
www.morningstar.com
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