Investors are usually torn between conflicting ideals: they want security and high returns. Banks, the first shopping stop for people looking to invest, have tried to create products that satisfy both of these needs. One such product is the non-guaranteed GIC. These GICs don’t guarantee an interest rate. Instead, their return is based on some external index. This is when GICs get risky!
Investing for High Returns with High Security
Occasionally, it seems that high returns can be achieved with high security.
For example, in 1991 I had some GICs invested with a 10.5% interest rate for 1 year. But that wasn’t as good as it sounds, because in 1991, inflation was 5.6%. That means the after-inflation return was only 4.9%. The profit was even less if I used a rate of inflation more realistic than the CPI. So that return wasn’t very high although the principal and interest were guaranteed and insured so the security was high.
Right now I have a few shares in a “blue chip” stock telco stock that pays a dividend over 5%. That rate isn’t as good as it sounds. At any time a company can cut its dividend or its shares can drop significantly in price. For example, if a class action lawsuit was successfully won against Canadian telephone companies, share values might plummet. There currently are several class action lawsuits brewing against the Telcos. So while the return is high, the security is low.
Why Do Banks Create These Specialty Market-Linked GICs?
Banks knew these market-linked GICs would appeal to both the investors need for safety and greed for growth. The banks had another motive, though. By carefully capping the maximum profits the GICs could earn, but by only guaranteeing the principal, the banks guarantee themselves a profit—with a better chance of capturing any upside profit than the investors!
An Analysis of the BMO Blue Chip GIC, a Typical Market-Linked GIC
Here’s an example of these risky non-guaranteed GICs. The Bank of Montreal offers a BMO Blue Chip GIC for 1 year that is RSP eligible. UPDATE: This analysis is based on a product on offer in 2013. The product may have been changed since that time.
- The principal is fully guaranteed.
(Not guaranteeing the principal would be a deal-breaker to investors.) - There is a guaranteed rate of return.
(This is honey to lure the bears.) - There is potential for additional returns.
(This appeals to greed.) - It is RSP eligible.
(This is strategic marketing. Many investors want GICs for their RRSP.) - It offers “exposure to a diversified basket of Canadian companies from various industries.”
(Note keywords: diversified; Canadian; various; companies; industries. The use of “basket” gives a picnic feel to the purchase, encouraging warm, cozy thoughts.) - The minimum investment is reported as a low $1000.
(Many conventional GICs can be bought at $500 or lower increments. This appeals to people who don’t have thousands to risk, but it still ties up a substantial amount of money for the investment term.) - It is eligible for CDIC insurance, up to applicable limits.
(They don’t mention the insurance is only on the principal.) - In the Details, they state that the GIC will be automatically re-invested unless other instructions are provided.
(This ensures if you forget it matured it will be rolled over locking it in for another year. This type of negative-option investing is quite favoured by banks. I hope they have improved their system for changing the reinvestment instructions. I had such huge problems with them in the past that I actually stopped investing in GICs with a major Canadian bank.)
It’s interesting that it will be automatically reinvested in a 1-year GIC at the current rate. It’s as if they KNOW you don’t want to re-invest in this Blue Chip GIC! - It is not redeemable prior to maturity and it is not transferable.
(If you get buyer’s remorse you’re still stuck.)
What Kind of Profit Can You Make from a Market-Linked GIC?
If you scroll down in the Details section for this product
Total Return Potential for the Term:
0.10% to 3.65% annually depending on the performance of the reference portfolio.
That’s right. The MOST you can make is 3.65% for the year. That doesn’t sound like a “high” return to me. Investing in BMO stock itself today would get you dividends of 4.608%!
The Three Strikes Against the BMO Blue Chip Market-Linked GIC
Strike One: The Choice of Stocks Used to Calculate the Rate of Return for the GIC
What do you think of when you think Blue Chip stocks? Personally, I tend to think telephone companies, banks, pipelines, and utilities. Here’s what BMO thinks:
AIM, Aimia Inc
PRE Pacific Rubiales Energy Corp.
G Goldcorp
MG Magna International Inc.
T Telus Corp.
TCW Trican Well Service Ltd.
TRP TransCanada Corp.
SC Shoppers Drug Mart Corp.
ESI Ensign Energy Services Inc.
CTC.A Canadian Tire Corp. Class A.
They have assigned a 10% proportion to each of those stocks.
I don’t even know what one of them is! (AIM). And the 3 energy sector related stocks are real no-namers too: No Suncor; No Imperial Oil. (Esso); No Irving Oil; No Husky.
According to their fact sheet, this GIC mirrors investments held 40% in Energy, 30% in Consumer Discretionary, 10% in Materials, 10% in Consumer Staples and 10% in Telecommunications.
Would that be your pick for a Blue Chip collection? As I said earlier, personally I would have expected:
20% Telecommunications; 20% Pipelines: 20% Utilities; 20% Banks; 20% Consumer.
Strike Two: The Dividends Are Not Used to Calculate the Rate of Return for the GIC!
I honestly expected dividends to play a role in the performance of the stocks and therefore in the expected rate of return for the GIC. So I researched the current dividends for the mirrored stocks:
AIM 4.172; PRE 1.931; G 1.86; MG 2.268; T 3.724; TCW 2.169; TRP 1.84; SC 2.669; ESI 2.575; CTC.A 2.029
Then I found the Product Profile sheet and discovered in extremely fine print, it says:
“The rate of return for the term is determined without reference to any dividends or distributions paid on the securities.”
In other words, they ignore the dividends when deciding if you get the 0.1% or the 3.65% !
Now by definition, Blue Chip stocks are chosen as investments because they pay good dividends and are stable companies. They are not usually bought because they have strong growth (capital gains) potential.
Yet the return for this Blue Chip GIC is based solely on the capital gains (growth) of these stocks!
Strike 3: The Method of Calculating the Growth is Subject to Change at the “Agent’s” Whim!
Ok, if the return for this GIC is based solely on the capital gains of the stocks it mirrors, I thought I’d look at the last 5 years of stock prices for each stock. Here’s what I found:
AIM climbing steadily. AIM has a lawsuit against it in the UK.
PRE big drop in 2011 and early 2012
G big drop in 2012, slight rebound in 2013, currently dropping
MG climbing quickly after big drop in late 2011
T climbing steadily
TCW big drop end of 2011 through 2012, leveled off in 2013
TRP climbing steadily
SC flat since 2011
ESI bounces annually but doesn’t really go up for last 4 years
CTC.A very slowly growing
Frankly, that’s not a very promising picture.
But it doesn’t really matter, because in the same very fine print in the Product Profile I found:
“Each variable rate of return is the average of the effective returns on each security in the Reference Portfolio on the applicable calculation date (the “Average Effective Return”). The effective return of each security is based on the actual return of each security calculated as the percentage increase or decrease in the price of the security (the “price returns”) from the second business day after the issue date to the applicable calculation date. The effective return of each security used to calculate the Average Effective Return on a calculation date is determined as follows : if a price return is positive, the effective return is the maximum return for each security as set out in the Terms and Conditions for the GIC; if the price return is equal to or greater than the minimum floor return as set out in the Terms and Conditions for the GIC but less than or equal to zero, the effective return is the price return; and if the price return is less than the minimum floor return, the effective return is the minimum floor return. If market disruptions or other special circumstances affect the calculation of the return, the calculation agent may adjust or delay the calculation or payment of interest, estimate the value of a security in the Reference Portfolio, replace a security and/or determine the amount of interest, if any, that may be payable in an alternate manner.”
I’ll make that last bit legible:
“If market disruptions or other special circumstances affect the calculation of the return, the calculation agent may adjust or delay the calculation or payment of interest, estimate the value of a security in the Reference Portfolio, replace a security and/or determine the amount of interest, if any, that may be payable in an alternate manner.”
Say, what?! Someone just gets to arbitrarily decide the amount of interest IF ANY based on an alternate manner which you have not understood or agreed to? They can “replace a security” without your knowledge?!
I CALL: “FOUL!”
And I call you a fool if you buy this market-linked GIC. (Sorry, Mom.)
Read and Fully Understand All the Terms and Conditions Before Buying a Market-Linked GIC
I suppose there may be some market-linked GICs that make sense. Based on the ones I’ve seen, though, I‘d be very, very wary.
If you lock in $1000 for 1 year with a guaranteed return of only 0.10%, you’ve basically agreed that $1 in interest is acceptable to you. $1. For one whole year. At ING Direct, based on the rate today on a RSP savings account you’d get 1.35% or $13.50 on $1000. I know which one I’d choose.
Background Reading:
- Stats Canada, Consumer Price Index Historical Summaries
- Financial Post Canada’s Telcom giants face $18-billion class action suit over system access fees. http://business.financialpost.com/2012/06/28/canadas-telecom-giants-face-19-billion-class-action-suit-over-system-access-fees/?__lsa=70f3-e215
- Other suits against Telcos
- http://www.classaction.ca/classaction-ca/master-page/actions/consumer-protection/current-actions/bell-canada.aspx
- http://www.cbc.ca/news/canada/north/story/2013/03/04/nwt-bell-mobility-lawsuit-anderson-911.html
- http://www.cjad.com/CJADLocalNews/entry.aspx?BlogEntryID=10491462
- Product Profile for the BMO Blue Chip GIC
http://www.bmo.com/pdf/term/BCGICSheet-Eng.pdf - GIC webpage for the BMO Blue Chip GIC
http://www.bmo.com/home/personal/banking/investments/gic/gic-navigator/bmo-progressive-gics/bmo-blue-chip-gic/details?tpFilter=0
Related Reading
- Pros and Cons of Buying GICs in a Self-Directed Online Brokerage Account
- Can I Cash my Guaranteed Investment Certificate Whenever I Want?
- Investing in GICs at the Banks an Exercise in Anger Management to Optimize Earnings
Join In
Have you had a bad experience with a market-linked GIC? Did you read the fine print and refuse to sign on the dotted line? Please share your experiences with a comment.
While I am not a fan of this product either, I believe they can have a purpose. That is for short term savings for large purchases where you can’t afford to lose any principle such as a down payment for a house, or car purchase. When you want to increase your potential gains, it may be worth the risk to try earning more with these GICs. Currently BMO and many of the big 5 banks are paying a 1.85~2.05% on a 5 year GIC. While the market linked GIC is not guaranteed, the loss of interest may not be that significant comparatively.
Also, it pays to shop around for these type of products. Scotiabank’s versions have a possible return of 56% cumulatively which work to about max 9.3% annually.
Lastely, Aimia is the company that owns Aeroplan and many loyalty programs throughout the world. They are a multi-billion dollar company. Currently banks in Canada are priced very high and probably have little growth ahead in next few years. These GICs are trying to max returns over a short term period (3-5 years), so it makes sense to have them structured in areas where the bank thinks will grow more so over the period of 3 to 5 years. This is different from a portfolio a everyday investor may have for a retirement 20-40 years ahead in time.
Again, thank you for a thoughtful analysis!
I agree that these GICs offer one way to take a gamble on getting a higher return–but I don’t think they are being marketed as a gamble. I’d be very interested to see some numbers from the banks on what previous certificates have paid out. I noticed a few years ago, when I wrote this piece, that BMO was not mentioning any successes anywhere in its brochures!
Yes, it’s VERY important to shop around if you’re considering one of these GICs. But you should also consider whether you’d be better off putting most of your money in a regular GIC and a small fraction into a low-fee mutual fund or other investment. Personally, I’d say if you need the capital kept safe for the short-term then you should probably just accept the lowest interest rate. And for sure check the interest rates offered on GICs. There are several CDIC-insured small banks and trust companies that offer much better rates than the big banks.
I haven’t seen the fine print of the Scotiabank version. Personally, I am VERY surprised that any of them are offering a potential gain of 9.3% annually. I’d want to go through that one in great detail before buying it.
I wouldn’t consider Aeroplan a blue chip investment although that’s interesting info. The bank itself is not investing the GIC-revenues in the specific companies it lists. It’s just taking the money into general revenues and using it as it deems most appropriate. The GIC is just paying out based on select companies such as Aimia. So I still don’t think that list of companies makes any sense under a title of “blue chip.” Nor do I really think the bank is picking what stocks to mirror the return from in an attempt to help the investor. However, I’m cynical about these investment products since I’ve talked to several people who have lost money on them. : )
Thanks again for sharing your views!