How to assess seg funds

Segregated funds are not the hot commodity they were a few years ago, thanks to tighter rules by securities regulators. But there is still a lot of money pouring into them. If you own any seg funds, or are considering buying them, here are some key points to consider.

  • Decide if the maturity guarantee is worth the extra money.
    The chance of a well-diversified, conservatively managed equity fund losing money over a 10-year period is small. The chance of a bond or balanced fund losing money is even less. I don’t believe maturity guarantees are needed at all, but I certainly cannot recommend paying high fees to insure a bond or balanced fund.
  • Consider the importance of the death guarantee.
    For older investors or those in uncertain health, the death guarantee could be the most attractive feature of a seg fund, especially if it offers 100 percent protection for your capital.

    This guarantee enables you to remain lly invested throughout your life, without having to retreat into low-paying, ultra-conservative securities for fear of jeopardizing the value of your estate.

  • Review the reset feature.
    This feature allows you to reset the maturity and death benefit guarantees. Not all companies offer it, so you may have to shop around. 

    The reset option kicks in if the fund increases in value. For example; suppose you invest $100,000 and six months later your fund is up 10 percent. Your investment is now worth $110,000, but your guarantee is only for $100,000.

    The reset privilege allows you to reset your maturity guarantee and death benefit to the new, higher value. You lock in your profit and, in the worst-case scenario, at maturity you — or your estate in the case of death — will receive a minimum of $110,000.

However, every time you use the reset you restart the clock. That means the maturity date is reset as well, to 10 years from the time of the reset. If you made your investment on January 1, 2002, your original maturity date would be January 1, 2012. But if you exercised your reset option on January 1, 2003, your new maturity date would be January 1, 2013.

Next page: Assess these benefits

Assess these benefits
I’ve noted that it is highly unlikely a maturity benefit would ever be exercised.

However, the death benefit is something else again and here the reset privilege has real value and represents a real potential cost to the insurance company — so much so that Manulife Financial had to rethink the reset privileges on its original line of Guaranteed Investment Funds (GIFs).

The new version of GIFs (called GIF Encore or GIF II) dramatically changed the reset options, making them automatic when tied to the death benefit.

That is not a bad thing, but it does show you how important it is for you to read all of the fine print in your segregated fund contract before buying.

The bottom line is that you must understand that if you buy seg funds, you’ll pay a premium price in the form of higher management fees.

You may consider that the cost is worth the added benefits, but be sure you look at all the options carefully before you act.

Often, traditional insurance company seg funds will be less expensive and will offer performance potential that’s every bit as good as the clones being offered by Manulife and others.

Excerpted from Gordon Pape’s 2002 Buyer’s Guide to Mutual Funds, by Gordon Pape and Eric Kirzner, published by Prentice Hall Canada.