As stock markets take a volatile ride amid the U.S.-China trade war and the possibility of a global economic slowdown, segregated funds may offer a measure of protection for nervous investors.
Segregated funds are insurance contracts that invest in an underlying asset such as a mutual fund, but differ in that they can provide a guarantee to protect some or all of the money that is invested.
However, the guarantees offered by segregated funds come at a cost, and advisers say it’s important for investors to understand exactly what they’re getting before adding such a fund to their portfolio.
Patrick Fitzgerald, an adviser with Sun Life Financial Inc. in Manotick, Ont., says segregated funds, which are sold by life insurance companies, are typically suited for conservative investors.
“It will associate with some level of stock market involvement or the potential to invest in the stock market, but also provide some of those guarantees,” Mr. Fitzgerald said. “So it has that nice blend of both worlds.”
In the event of a stock market crash, a segregated fund would protect some of or all of your principal, but you generally have to hold the investment for a minimum period of time. There are also additional costs related to the insurance protection.
Business owners can also use them to protect investments from creditors if something goes wrong and they face the prospect of having assets seized.
Segregated funds usually carry higher fees than equivalent mutual funds and you may face a penalty if you need to withdraw the money earlier than specified in the contract.
Kelly Gares, an investment adviser with BlueShore Financial, suggests that segregated funds are typically aimed at older clients who are well into their retirement and focused on protecting their capital.
“The sweet spot in my opinion is clients that are probably in their 70s, could be late 60s, but I would say kind of 70s, possibly even 80s,” he said.
“The reason for that is at that stage they are probably more certain about whether or not they have enough money to fund their retirement.”
Mr. Gares says investors looking for estate planning may also benefit from the insurance features of segregated funds.
“That is really where the segregated fund can make a lot of sense,” he said.
Depending on the fund, there can be a guaranteed death benefit that will see your beneficiaries receive a guaranteed payment based on your initial investment when you die. The amount is not subject to probate fees if your beneficiaries are named in the contract.
Mr. Gares says clients who have benefited from the recent bull market may be looking to help protect those gains and pass them on to their beneficiaries even if markets tumble.
“So maybe moving away from a conventional equity portfolio or a mutual fund into a segregated fund is a way of kind of drawing a line in the sand,” he said.
Mr. Gares adds that segregated funds are not a do-it-yourself investment because investors need to navigate the details involved in the insurance contract to ensure they understand the risks and restrictions, which can differ from company to company.
“You really do need to understand all of the terminology, that’s why working with an adviser that’s well versed in the product itself really is to your advantage,” he said.
But Sun Life’s Mr. Fitzgerald says it can be part of a diversified portfolio in the right situation.
“It’s not a one-size-fits-all approach, but we do feel clients need to be educated on what this is doing and what the potentials are for this.”