You have 2 free articles remaining. Subscribe
Dec 27, 2014

Banks’ ‘Dirty Little Secret’

by Tom Bradley

Tom Bradley“There are those who know and those who don’t. All the advantages go to people who know.”




These words are from investor advocate Glorianne Stromberg in 1998. She was speaking to the ramifications of the ‘knowledge gap’ between investment professionals and their clients.

I’m reminded of the knowledge gap every time I open the newspaper, or walk by a bank branch, and see an ad for an index-linked GIC. Despite intense industry criticism, these products remain in vogue and are heavily promoted by the banks. Investor Economics reported that marketlinked notes have increased from $4.9 billion in 2003 to almost $25 billion by June 2013. The number is likely much higher today.

Index or market-linked notes usually have a compelling name and blatantly overstate their benefits. For instance, the latest offering from RBC, called a MarketSmart GIC, comes with the tagline, “Nothing to lose. More to gain.” What could be better than that?

I haven’t talked to Glorianne about this, but I’m sure a MarketSmart GIC would make her blood boil. Certainly, the ads made my blood hot enough such that I pulled up the sales document and went through it. A number of things jumped out at me.

First of all, these GICs are available in different terms (two, three and five years) and have a variable return that’s linked to a particular stock index (i.e. the S&P 500 in the U.S. or the Canadian banking index). My comments below are based on the 5-year U.S. MarketSmart GIC.

The return formula is one that only a math geek could love. It’s linked to the index return, but there’s a minimum and maximum. If the S&P 500 Index goes up less than 5%, then you get the minimum (5%). If the index goes up more than 5%, you get the index return until you get up to the maximum (25%). In other words, if the index has a return of 30, 40 or 50%, you get 25%.

Comparing Bad Apples To Oranges

It’s important to note, the numbers advertised are all ‘cumulative’ returns, as opposed to ‘annualized’ returns that are reported by every other investment product known to man. In return for locking your money up for five years, you will receive a ‘cumulative’ return between 5% and 25%. According to my math, this translates into a range of 0.98% to 4.56% per annum (there are no per annum numbers to be found in the sales document).

In the latest ads for a thee-year MarketSmart GIC, RBC has chosen to feature the maximum cumulative return. For a product that will generate an annualized return between 0.5% and 2.9%, there is a giant, gold 9% emblazed across the ad.

While I was getting my mind around the reward vs. risk of the formula, it hit me that there was no mention of dividends, even for the note linked to the Canadian bank index (investors love their bank dividends). This omission comes despite that fact that dividends are an important part of the stock market’s return.

But no, the index on which the MarketSmart return is based is a price index, which does not include dividends. I did a rough calculation and dividends alone from the Canadian banking index (assuming no increases) would generate a cumulative return of 19% over five years.

I should note that the no-dividends feature of the MarketSmart GICs is not unusual. All of the products that Scott and I have looked at over the years have this design element. It is the banks’ dirty little secret.

And finally, I thought I should test the ‘Nothing to lose’ hook. This statement didn’t ring true to me because a conventional 5-year GIC at Tangerine (formerly ING)  yields 2.55%, well above the MarketSmart’s 0.98% minimum return. Indeed, there is something to lose if the market was to do poorly. On a $10,000 investment, the investor would earn $284 less than a Tangerine GIC. Not ‘nothing’.

My conclusion from going through the sales document and reading the fine print is - DON’T BUY THESE PRODUCTS! Listen to Glorianne Stromberg, who was way ahead of her time. Don’t let the banks take advantage of the knowledge gap.

(I would invite anyone from the banking industry to correct or add to my analysis. Please tell me where I’m wrong or what I’m missing.)

Tom Bradley, President and Co-founder of Steadyhand Investment Funds