Segregated index funds hit the market

By Mark Noble | January 13, 2010 | Last updated on January 13, 2010
3 min read

The indexing trend has pushed down another product barrier, with the launch of a new line of segregated index funds and guaranteed minimum withdrawal products by Pro-Financial.

With a growing number of boomer clients nearing retirement, segregated funds have grown in popularity, thanks to their capital guarantees. The biggest complaint they draw from advisors is that they are expensive, with the extra fees eating into upside growth potential.

Pro-Financial is attempting to alleviate this problem with the launch of the PRO-SSQ Guaranteed Investment Portfolios products that will be anchored by a suite of lower-cost index mutual funds that use Research Affiliates Fundamental Indexing (RAFI) methodology.

There will be four portfolio choices available, all of which offer one-stop investment choices with quarterly rebalancing, global exposure and varying degrees of equity exposure to suit the main investor risk profiles: Conservative, Balanced, Growth and Aggressive. The aggressive portfolios even include exposure to emerging market index funds such as the FTSE RAFI Hong Kong China Index Fund.

SSQ Financial Group is providing the insurance features on the funds, which includes options for both 75% and 100% capital guarantees and death benefits. The costs on the portfolios run from 247 to 263 basis points.

“The primary advantages of segregated funds over mutual funds are as follows: segregated funds offer principal protection, death benefit guarantees, they can provide possible creditor-protection, and can bypass probate,” says Stuart McKinnon, president and CEO of Pro-Financial Asset Management. “This normally comes with a premium price over mutual funds, but since our portfolios are 100% indexed you’ll note that the all-in MERs on these segregated fund portfolios are in the range of traditional mutual fund portfolio programs.

“For essentially the same costs, investors can now get these added benefits over their mutual fund portfolio funds.”

Preet Banerjee, senior vice-president with Pro-Financial, also points out that a capital guarantee on an index enhances the benefits of indexing, providing downside protection on the indexes. On top of that, segregated funds can distribute realized capital gains and losses. The investor can then carry back the capital losses up to three years or carry them forward indefinitely. Indexing allows those benefits to come in at a much lower cost.

GMWB riders are available on the index funds on a deferred sales charge basis.

“The GMWB will pay out 5% guaranteed annual income for life if the benefit is exercised after age 65 or 5% for 20 years if the investor is younger than 65. There remains an option to get income for life at age 65,” he says. “Investors are allowed to reset the principal value of the portfolio every three years.”

Banerjee says now is a good time to launch a GMWB product, because much of the downside risk has been eliminated from the underlying portfolios — for the provider, there is less risk of taking on financial stress to pay back the guarantees that some other insurance providers have faced.

Ultimately, the biggest impact these products may have on the market is that it opens up 100% index products to insurance advisors who may not be IIROC or MFDA licensed.

“This eliminates that difficult conversation advisors have when trying to explain why a mutual fund has not beaten its underlying benchmark index. The client asks ‘Why not just buy the index?’ You don’t have to have that conversation anymore. Advisors are starting to pick up on the case for indexing and this gives them an option to offer indexing,” Banerjee says.

It’s important to note that the RAFI indexes used by Pro-Financial are not traditional indexing strategies.

The Fundamental Index methodology selects and weights securities based on four fundamental factors —s sales, dividends, cash flow and book value — rather than a traditional capitalization-based weighting. There will be some variation between a cap-weighted index and the fundamental index.

Banerjee argues the RAFI methodology is superior.

“You won’t find companies dominating a fundamental index based on hype and pure speculation,” he says. “For the 2009 calendar year, the PRO FTSE RAFI Canadian Index Fund (Class F Units) returned 42.86% while the S&P/TSX Composite (Total Return) Index returned 35.05%. That represents an out performance of 7.81%.”

(01/13/10)

Mark Noble