As exchange-traded funds, F-series funds and no-load funds gain ground, segregated funds must clearly demonstrate their added value if they want to carve out a place among the solutions offered to increasingly cost-sensitive investors.

Strategic Insight data show that segregated fund assets increased from $110.7 billion to $116.8 billion between June 2016 and June 2017, equal to 5.5 per cent growth.

Market trends in the coming years will propel investment product costs downward. “Management costs will become a greater focus,” Benjamin Reed-Hurwitz, consultant and senior analyst at Strategic Insight, told The Insurance and Investment Journal in an interview. “Growing adoption of fee-based practices by advisors will continue to push the discussion around low cost products, and could be beneficial to exchange traded funds (ETFs), as they can easily be included in fee-based programs,” he adds.

Mutual funds have reacted well to these trends, Reed-Hurwitz continues. “We see that many mutual fund companies are responding very aggressively in terms of pricing, especially with their F-series funds, which is in the fee-based category (F-series funds have largely been built to be incorporated into fee-based practices). ETFs are in a good position in terms of competing in a fee-based world but mutual funds are also increasingly well equipped to compete,” he points out.

The trend toward low-load funds is building in mutual funds, under pressure from ETF and fee disclosure, says Alain Huard, Vice President Retail Sales, Quebec at Invesco Canada. “Sales of F-series funds have risen sharply, in both the securities brokerage network and among financial planners. Back-end load products are dwindling. For us, the proportion of sales attributable to these funds has become minimal. No-load funds still make up a good proportion of our sales, he says.

Fee-based work is a real challenge, says Alain Desbiens, Vice-president of sales, BMO ETFs, Eastern Canada at BMO Global Asset Management Canada. “Investors want a choice and a transparent model. The use of ETFs in securities firms is growing, mostly in fee-based accounts, both discretionary and nondiscretionary, he explains 

Desbiens has also noticed greater use of F-series mutual funds that comprise ETFs, including in underlying funds within segregated funds.

Demonstrating value

Given the mounting pressure on costs, what will happen to segregated funds which have an extra insurance cost? One challenge will be to justify the additional cost, Reed-Hurwitz says. “As segregated funds have to justify both against mutual funds and ETFs, there will be focus on the insurance component of segregated funds. The question will be: does the additional cost of the guarantee provide value over a mutual fund or an ETF?” Reed-Hurwitz says.

Regarding the added cost of investment and advice, each of these components will be looked at, he adds. Suppliers may then want to integrate ETFs in their segregated funds because they think this will help them lower the cost of the insurance component within the segregated fund expense ratio, he says.

“It’s really about discovering what an investor actually values: the personal touch that mutual funds have with established fund managers, the active part of an ETF, or just exposure to the market at the lowest cost? The real challenge will be to define the value narrative of each investment product, and the rapid adoption of fee-based is going to push that conversation,” Reed-Hurwitz explains.

Middle class investors can thus access segregated funds that can offer a large index base and that integrate smart beta strategies at a reasonable cost, including individual strategies based on covered options and low volatility, Desbiens says. “We offer ETF portfolio segregated fund solutions for initial deposits of $500. The whole line of automatic deposits and reinvestment is also available starting at $50 per month. Advisors can therefore find solutions to cover 70 per cent of Canadians whose investable assets are $50,000 or less,” he said. 

Net seg fund sales

Net sales of $710.9 million that segregated funds racked up between January 1 and June 30, 2017 have massively flowed toward international funds. International balanced funds accounted for nearly 57 per cent of sales, versus about 29 per cent for US equity funds, according to data The Insurance and Investment Journal obtained from Strategic Insight.