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The Money Management Newsletter: Investing in Mutual Funds
The pro's and con's of Seg Funds
Understanding the fine print

By Rob Whipp
Money Management Newsletter

Seg funds, like any investment come with an inherent level of risk associated with them, but do the benefits outweigh this negative factor? Below we have discussed both sides of the story.

The pro's

Guarantee of Capital:

This may vary among companies but essentially there is a maturity date normally 10 years after an investment is made at which time the investor is guaranteed to receive a specified percentage of the deposits made in the first year (less withdrawals) or the market value of the investment, whichever is higher. Each additional investment has its own 10 year period and of course once the 10 year maturity date is reached a new one can be started subject to age limitations. This capital guarantee is however reduced by withdrawals and fees such as switch and redemption fees.

Guarantee at Death:

This again will vary among companies but it provides for the return of the market value of the investment or a specified percentage of invested capital (less withdrawals), whichever is higher, to your estate or beneficiaries at death regardless of how much or little time has passed since your money was invested.

Reset Option:

This is an attractive feature that allows you to lock-in investment gains and increase your capital guarantee without redeeming the investments. For example if your initial investment was $50,000 and two years after starting your policy this amount had grown to $60,000, you could then reset your capital guarantees based on this higher amount. You would, of course, start a new 10 year maturity date. This feature will also vary among companies according to the number of times per year that you can take advantage of this option.

The con's

Higher management fees:

We have covered some of the insurance benefits but what are the drawbacks if any? Well as you know, you never receive something for nothing and in this case the cost is in the form of higher management fees to cover the cost of the insurance. There has been little claims experience on this funds since they're relatively new so these fees may be adjusted upward over time.

Reduced portfolio growth over time:

Young investors will find that the higher management fees cut into the value of their portfolio over many years of investing. Also, over a 10 year time frame, you would expect the value of most investments to double so the return of capital guarantee may not seem that attractive. More mature investors who are more sensitive to estate planning and death benefits may find that the higher management fees are worth the guarantees.

Make sure you understand the product:

It is imperative that, if you are considering or are being sold a seg fund, you carefully read the information folder (seg fund version of a prospectus) to ensure you understand the product. Seg funds can vary widely as to their features and benefits and it is possible that someone recommending a seg fund to you will not be totally familiar with all of the aspects themselves. The guarantees are probably the reason you are considering the seg fund in the first place, so do your homework.

No shareholder rights:

One last point to note is that a mutual fund owner has shareholder rights while the seg fund holder does not. Mutual fund holders will be notified of annual meetings of the fund company and have voting privileges and some say in changes to their fund. Conversely the corresponding seg fund owner does not have any shareholder rights. In this case the company can unilaterally make decisions regarding the fate of a fund such as merging it with another or increasing fees with the only requirement being to provide the investor with prior written notice. The company's rights again are noted in the information folder.

As complicated as it might be your best bet is to become completely familiar with the information folder to ensure you understand what you are getting with your seg fund investment.