I prefer not to name the particular product Colin is considering, so I’ve edited his question somewhat:
I am looking at a term deposit product. In the description they state ‘Market Participation: 100% or higher depending on the issue.’ Can you describe what they might mean by Market Participation in this context and, in addition, how it could be greater than 100%?The product Colin is considering is linked to the S&P/TSX 60, which is an index of 60 of the biggest companies in Canada. It guarantees a minimum of 4% interest after 5 years (about 0.79% per year), and may pay more based on a calculation related to the S&P/TSX stock index.
The advertising claims a “Market Participation” rate of “100% or higher.” This sure sounds like you get all the stock returns if stocks go up (or maybe even more than all), but none of the losses if stocks go down. But Colin is right to be suspicious. There are three unpleasant surprises hidden in the detailed calculations.
The first bit of bad news is that the interest upside is capped at 27% over 5 years (4.9% per year). The advertising actually says that the range of annual returns is from 0.8% to 5.4%, but in the real world we have compound interest.
The second piece of bad news is that the S&P/TSX index doesn’t include dividends paid by the companies that make up the index. Dividends are an important part of stocks returns that stock owners receive. But investors in this product will not benefit from dividends.
And finally, the returns are roughly chopped in half by an averaging calculation. Instead of just calculating stock returns by looking at prices at the beginning and end of the 5-year period, they take the prices each month for 60 months and average them all. The “return” is then based on the starting stock prices and this average figure. Typically, this will cut returns by slightly more than half. Then this “Average Growth” figure is multiplied by the market “Participation Rate.”
So, the advertised 100% market participation actually consists of removing dividends, chopping the remaining return roughly in half, and then capping it if it still happens to be too high. This is definitely a case where reality doesn’t live up to the marketing.