One of the things that we share with clients and prospects is that there are many type of investors out there as well as many more investment products. Every client situation is different and the product solution is unique. That said, we advise clients of the truths and myths behind the product choices.
One of the most misaligned investment products are segregated funds. While they are not for everyone, they do provide certain features that are well suited for some investors.
For the typical investor, it might be too easy to question the value of segregated funds, especially if they’re the cost conscious type that benefited greatly from the rise of low cost passive investing. But the most common criticisms levelled against segregated funds overlook some key facts.
One common worry is that segregated funds don’t perform as well as their mutual fund counterparts. In actuality, the funds may be very similar but higher fees for segregated funds might mean the client receives lower net returns.
Fees
Fees don’t tell the whole story, and those weighing mutual funds against segregated funds must take care to ensure they’re comparing apples to apples. Yes, a segregated fund might have slightly higher fees, but you’re also getting a lot more. Segregated funds allow you to bypass the estate which saves probate fees as well as time. In some cases, they may offer creditor protection.
Investors have also been quick to criticize segregated fund fees. According to Morningstar, the average fee for a segregated fund with a 75% capital guarantee is 2.92%, and 3.27% for a 100% capital guarantee. A basic balanced mutual fund, in contrast, would come with a 2.3% fee on average.
Options
Another misconception held by investors is that there aren’t many options for segregated funds. Over the years, large financial institutions and major insurers have been making great efforts to build out their product shelves.
Additionally, segregated funds have built in maturity and death benefit guarantees. These allow clients some peace of mind that in certain situations, their investments won’t decrease beyond a certain point regardless of the markets.
In 2022, the Canadian segregated fund space welcomed new exchanged traded (ETF) segregated funds and environmental, social and governance (ESG) segregated funds among other new innovations. Segregated fund providers also typically include a variety of asset allocation strategies on their shelves.
Suitability
Segregated funds have many investment options to suit different types of investors and their risk profiles. Ideally, the client would also be shown different investment options to decide what the best solution is for their needs. But that comparison only scratches the surface.
Both mutual funds and segregated funds are appropriate in different situations. For example, someone in their 30s with no dependents might be looking for the lower fees mutual funds can provide, whereas someone in their 70s might find more value in estate planning which is where segregated funds really shine. A risk-averse investor may feel more comfortable knowing segregated funds carry certain guarantees. Throughout a person’s lifetime, they may find that they hold both mutual funds and segregated funds or move from one to the other.
Segregated funds are similar to a mutual funds with an insurance wrapper. For a client who’s interested in estate planning, creditor protection, and guarantees, a slightly increased fee might be a small price to pay for those features.
Conversely, if they are more interested in lower fees and don’t see the value in the additional benefits of a segregated fund, then a mutual fund may be more appropriate.
The bottomline
Recently, segregated funds have been a point of debate in the wealth industry, as regulators point to risks of poor consumer outcomes from the products. Advisors hold the key to the proper use of segregated funds in financial life plans.
As a client, you want to work with an advisor who can offer various investment options such as segregated funds, mutual funds, and ETFs. We take the time to understand your unique position and offer options that work for you. It is also important that you work with someone who regularly reviews your accounts with you to ensure your financial life plan stays on track Keeping Life Current.
