What You Need to Know: Guaranteed MPFs

Investors may be paying a high price to achieve a sense of security.

Kate Lin, CAIA 15 July, 2021 | 10:32
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Guaranteed funds, the third-largest slice of MPF assets, gathered more than HK$700 million (US$90.2 million) from Hong Kong workers as of the end of last month. Guaranteed funds’ conservative risk profile can benefit to your future retirement pot, but the strategy is not defined for every life stage.

 

Know What You Own

It is important to first understand how MPF managers design guaranteed funds and what can be guaranteed.

By Morningstar’s definition, guaranteed funds are offered in two flavors. They either guarantee the repayment of invested capital (either all or in-part), or promise a pre-determined rate of return.

Having your capital preserved is great, but unlike promises we make to our loved ones, this promise comes with a price and conditions.

A guarantor, usually an insurer, charges a fee for the managing risks. This charge is added to the management fee. As a result, guaranteed funds are more expensive than most of the low-risk fund categories.

The guarantee offered is conditional and can vary from one fund to another depending on the investment objective stated in the prospectus.

For example, the guaranteed return will not be applicable if investors withdraw before the minimum holding period or make lower contributions than are required. Guarantors may also be allowed to cancel the guarantee at their discretion if they provide advanced notice. In certain cases, they can remove the promised safety net, say in the face of unfavorable market conditions, where protection of capital is the most the most needed.

 

Are Guaranteed Funds Worth Considering?

Considering all these drawbacks, is a guaranteed fund still a worthwhile investment option?

It depends, but the conclusion takes more than ‘promises’ to make.

Most younger contributors can assume wealth to accumulate steadily over time. For a period long enough, one’s human capital, which is the ability to earn money over time, has room to grow. Such expectations ultimately impact how one would allocate MPF investments. With many income-earning years ahead, an investor can take on more risk with a more aggressive allocation.

The ‘guaranteed’ feature typically appeals to those who are still on the job but are planning for an imminent retirement. Until they are eligible for a withdrawal, the promised returns and guaranteed capital invested provide a favorable margin of safety.

Guaranteed funds usually are less risky (as measured by standard deviation) than the market average, but they bear some unique risks that aren’t taken on in other MPF categories. For instance, the failure of a guarantor can lead to a return that falls short of expectations. Furthermore, guarantors with an insurance background add credit risk to the investment.

 

Alternatives for Consideration

Lastly, for those who have already allocated MPF assets to guaranteed funds, a regular portfolio check-in may be worthwhile to keep up with any changes in the terms. Before switching MPF managers, make sure you read through the terms and conditions to avoid giving up the promised returns.

As said, guaranteed funds incur additional fees and their terms can vary. Here are two aspects one can consider.

If fee is a top concern in constructing a MPF portfolio, there is a range of cheaper alternatives (in yellow mark) that generate a better risk-adjusted return over the past three years versus guaranteed funds.

 

Category Performance/Fee Comparison

 Fee concerns

Moreover, in building a low-volatility MPF portfolio, investors can compare risk-adjusted return and risk among individual funds or among MPF categories. Volatility of guaranteed funds, as measured as standard deviation, typically ranges between 0% and 0.4%. Selective bond and mixed assets MPFs are a cheaper alternative for conservative investors who want to get around wordy terms and conditions. Bonds share some risk-return features with guaranteed funds, though without any guarantees on principal. The Age 65 Plus Funds are globally diversified portfolios. They invest 80% of total assets in low-risk assets, mainly global bonds and the remaining of assets goes into higher-risk equities, which allows these funds to deliver higher than guaranteed funds with the same level of risk.

Low Risk MPFs

 

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About Author

Kate Lin, CAIA

Kate Lin, CAIA  is a Data Journalist for Morningstar Asia, and is based in Hong Kong

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