March 16, 2010, 4:34 am

Segregated funds: The High Price of Security

by: The Financial Blogger    Category: Investment, Market and Risk
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During the RRSP campaign, I met one of my clients who held investments with Manulife for a while. During our meeting, he showed me his investment statements from the other company. He had invested in segregated funds for the past 10 years and wasn’t happy with the results. While I am not bashing Manulife (I still took it in my portfolio for our best 2010 stock picks contest 😉 ), I can’t say that I am a big fan of Segregated funds either!

What is the difference between a Segregated fund and a Mutual fund?

Segregated funds (also called seg funds) are one of the strange beasts created by some crazy financial scientist in the labs of insurance companies. They are very similar to mutual funds when we look at their investment composites. If you look in your track investment apps you will see that there are seg funds for every kind of investor profile. However, when you call a life insurance investment services, they will explain the difference between segregated funds and mutual funds.

Segregated funds are held within a life insurance policy. This means that they are part of the policy paid to your beneficiaries if you decease.

Segregated funds usually come with a partial to full capital guarantee. The term to benefit from this guarantee is usually 10 years. After this period, your capital can be guaranteed at 75% to 100%.

Segregated funds: paying a high price for a small security

As you can see, Seg funds are quite similar to mutual funds. However, there are some major cons of buying them.

#1 Seg funds have higher MERs

Management ratios is one of the most important metrics you need to analyse when looking at an investment. If your fund has a 3% MERs, this means that you start January 1st of every year with a yield of -3%. It can be hard for a fund manager to overcome this obstacle.

You won’t be surprised that segregated funds have the highest MERs in the  world funds. This can go from 0.25% to 1% more than a management fee on similar funds without the guarantee of capital.

#2 Does the segregated fund security of capital really worth it?

When you think about it, most balanced mutual funds are showing positive results over a 10 year period. And rarely you will see a fund returning only 75% of their value after 10 years. However, if you are doing selective and highly speculative trades (like buying techno funds in 1999), your guarantee can be worth something today. But if you follow an established asset allocation, you would never need this kind of guarantee over 10 years.

#3 Other segregated fund fees

You may think by buying an investment fund with MER fees 30% higher than others that you would be done with fees. Well, my friend, you may also end-up paying both front end and back end fees. While front end fees are usually waived by the advisor (who is looking for his commission after all 😉 ), the back end fees are usually in place (which guarantees the advisor a higher commission pay check at selling and trailer fees for at least 5 years. if you don’t want to pay fees to sell the fund).

Final thoughts on segregated funds

As you can see by now, I don’t really like seg funds ;-). If you are really looking for capital security and still want to benefit from the market growth, I suggest you consider linked notes. You will still be paying a high price (in my opinion) for security but you will get a better return (if you take the time to buy the right one 😉 ).

Do you have seg funds in your portfolio? How are they doing? Do you like them?

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Link-notes? Really? did you ever take a good lok at them? Do you really understand how the returns are calculated? for me it’s a no no…

you missed some other points about seg funds: creditor protection, year end distribtuin (for non-registered), by doing some research you will find some with resonable MER

by: The Financial Blogger | March 16th, 2010 (1:03 pm)

@JF, if you read the article I am linking to in regards to linked notes, you’ll see that I am not a big fan either.

I actually don’t like Seg funds and linked notes 😉

creditor protection; you are right, missed this one. year end distribution… mutual funds do the same thing, don’t they?

i don’t think I would have been too happy owning Manulife right before they slashed their divvy in half; however, if the yield was at least 3% right now, I would take a serious look. I think it has some solid potential upside for 2010 and beyond and it seems like you made a good pick.

I don’t own any seg funds in my portfolio. I’m also not fond of high MERs and tend to stay away from investing in anything that has high management fees.

I’m confused by your statement. You can choose investments from a shelf of products. MERs are based on the funds you pick. So, if you can’t sell seg funds, which offer fantastic guarantees of capital, great estate benefits and also a wide array of investment options, I know why you’re cherry picking your cons.

Also, MERs should only be a concern if the mandated management schematic is the same from one product to another. In no circumstance should clients shun MERs until they understand why there are differences. Otherwise, you’re not only skipping half the information that should be presented but your selling by cost and you will lose the client as soon as someone shows them lower MERs after your DSCs are gone. This then keeps the client in a world where they think cheaper is better and it isn’t usually the case.