Stock Market Returns Without Risk to Principal

Two insurance companies have introduced products that pay stock market returns but with no risk to principal, reviving an idea that has been tried with limited success in the mutual fund business.

The products are “equity-indexed� fixed annuities, not mutual funds. In fact, they aren’t defined as securities, but rather as insurance policies. Yet stock market performance weighs heavily in their appeal, and if the idea catches on, these vehicles could emerge as competition for mutual funds and their close cousins, variable annuities.

The concept behind indexed annuities is fairly simple. The insurance company guarantees your principal won’t drop if the stock market does. But if prices rise, the insurer shares some of the profits with you.

There are other benefits associated with fixed annuities, such as tax-deferred compounding, penalty-free withdrawals of some cash and a policy-cancellation period. But common annuity drawbacks such as tax penalties and surrender charges for premature withdrawals might also apply.

But what makes these products unusual is the effort to couple returns linked to the Standard & Poor’s 500 index with no risk.

“The insurer does this by taking the bulk of the money and putting that into high-grade corporate bonds,� says Tina Baughman, president of Independent Advantage Financial in Marina del Rey. “With a small percentage of the money, the company buys call options on the S&P; 500.�

The bonds provide the price guarantee, while the options generate the potential for stock market profits. With options, small dollar stakes can reap big gains.

The two equity-indexed annuities differ a bit in how they propose to deliver stock market performance.

The KeyIndex annuity from Keyport Life Insurance Co. of Boston currently credits policyholders with 85% of the gains on the S&P; 500 with no yearly “caps� or limits. So if the S&P; 500 climbs 20%, you earn 17%.

The Savers Index annuity from Lincoln Benefit Life Co. of Lincoln, Neb., also offers an 85% “participation rate,� but with gains capped at 14% a year.

For these results to kick in, you must maintain your policy with Keyport for five years and with Lincoln Benefit for seven.

The annuities debuted in 1995 and are sold by various brokerages, banks, insurance agencies and financial-planning firms.

Baughman favors KeyIndex because of its shorter minimum period and lack of performance caps. But James Rapisarda, a principal at Glass Financial in Phoenix, prefers the Savers Index because of what he says is a “lock-in� feature that credits gains yearly, not just over the full term.

And there are other product wrinkles, which could become more numerous if competitors enter the market, as is likely.

While efforts to couple stock market gains without risk may succeed in annuities, the concept has met with mixed results among the few mutual funds that have tried it.

For example, the Gabelli ABC Fund of Rye, N.Y., secured third-party insurance to guarantee a 5% return in 1994 for investors who bought shares, reinvested all dividends and held for the full year. Yet the fund attracted less than $30 million in assets in its promotion--half the amount expected.

Similarly, Lord Abbett & Co. of New York introduced a stock fund in 1990 for which it also obtained third-party insurance and guaranteed to return shareholders’ original principal in the year 2000 provided they reinvested all dividends and held for the full 10 years. But Lord Abbett garnered less than $100 million, compared to a goal of $750 million, and hasn’t unveiled any such funds since.

Wall Street has experimented with various combinations of stocks, bonds and even gold coins in an attempt to deliver stock market returns with a price floor. Many of these efforts have come as unit trusts--unmanaged portfolios that are cousins to mutual funds.

Underscoring all of these efforts has been a realization that stocks move higher over time. Investors willing to stay the course for five years or more will probably break even, with or without a guarantee.

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The 10 funds in the Venture Advisers family are changing their names and will be listed under Davis Funds in newspaper tables. Veteran stock picker Shelby Davis is owner of the group and co-manager of the flagship New York Venture Fund. The group counts $2.7 billion in assets, with more than half of that in New York Venture. The family is based in Santa Fe, N.M., but portfolio management decisions are made in New York.

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Bridget Macaskill, already one of the highest-ranking women at a major fund company, will become chief executive of Oppenheimer Management Corp. on Sept. 30. Macaskill currently is chief operating officer and president of the New York firm, which counts $38 billion in assets. She takes over the CEO post from Jon Fossel, who will remain Oppenheimer’s chairman.

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The Longleaf Partners Fund has closed its doors to new shareholders. A sibling portfolio, Longleaf Partners Small Cap, remains open.

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Dealing with Risk and Return

New equity-indexed annuities blur the distinction between fixed annuities, variable annuities and even mutual funds. Here’s the major differences.

* Fixed annuities. Investors earn a guaranteed return tied to bond-market yields, with no risk to principal--provided the insurance company remains solvent.

* Variable annuities. Investors can choose among different stock and bond options. These alternatives offer greater profit potential than fixed annuities but investors face greater risk.

* Mutual funds. Investors rather than fund companies bear the risks of price fluctuations, even on money-market portfolios.

* Equity-indexed annuities. Investors share in the profits if the stock market rises but recoup their principal if prices decline.