Segregated (seg for short) funds are professionally managed investment funds holding pooled investments, with a life insurance component.

With predefined investment objectives and policies, a professional manager selects the assets the seg fund will hold. Many individuals pool their money for the purpose of investing in stocks, bonds, and other kinds of securities by purchasing shares or units. The price per unit fluctuates in relation to the market price of the securities the fund holds. Fund investors get a share of the fund's ongoing investment earnings or losses, based on the number of units they own. When they redeem or sell units, the redemption value or price they get depends on the number of units redeemed, the unit price at the time of redemption, and any applicable fees.

The advantages of segregated funds during market turbulence

Seg funds can offer growth when the market increases in value

Seg funds allow investors who have only a little capital or limited investment knowledge to invest in a diversified portfolio of assets. Individual investors share the expenses of running the fund, such as employing a professional manager who buys and sells assets. They are very liquid; in other words, individual investors can cash out at virtually any time by redeeming their units with the fund issuer.

1. Diversity reduces investor risk The more diversified a fund is, the greater the mix of assets it holds in its investment portfolio. As a rule of thumb, the more diversified the fund, the less potential there is for it to suffer drastic losses insofar as the markets are losing value as in the 2007-2008 Great Crash. When one or more of its investments does poorly, others may be doing fine. The converse also holds true: the more specialized a fund is in terms of the kinds of assets it holds, or the industry or part of the world it invests in, the greater the potential for significant gains and losses. As with all investment products, there are other kinds of investment risk, such as inflation risk, declining market risk (referred to as bear market), default risk, currency risk, interest rate risk, and political risk.

2. Guaranteed safeguards The most compelling reason for buying a seg fund policy is capital protection. While GICs also offer a guaranteed return, they are limited in their growth potential. Since seg funds are invested in capital markets, they have a greater capacity for appreciation. Segregated fund contracts have special features over and above those offered by other investment funds.

3. A guaranteed maturity benefit The seg fund's contracted maturity date at 10 years (some are up to 15 years), or at death, guarantees a minimum of 75% (some up to 100%) of your invested capital (by a life insurance company). Typically, at the time of maturity set in the contract, some companies permit a resetting of the new guaranteed capital amount and a renewed maturity date.

4. Locking in capital gains The seg fund's reset provision actually allows you to lock in capital gains, thus increasing the protected amount until the next maturity date. For example, if your initial investment of $500,000 increases to $800,000, you may reset the guarantee to protect the entire $800,000. The reset can be a valuable tool for investors with a longer time horizon or for those whose funds appreciate significantly. After the last market crisis, many investors want the peace of mind obtained by safeguarding their capital from market losses (which is dependent on the timing of the contract provision which should be discussed).

5. Or take the money Regardless of market performance, at maturity you are entitled to receive most or all of your initial invested capital back (or more if the market has performed well), less any withdrawals. Legislation states that at least 75% of the initial investment (some up to 100%, depending on the contract, which may change in the future) must be returned. Note: Examine the conditions of the contract.

6. Estate planning guarantees As with the guaranteed maturity benefit, some insurance companies allow individual contract owners to reset the guaranteed death benefit periodically to lock in increases in the value of the segregated funds the contract has invested in, equal to at least 75% (and sometimes as much as 100%, depending on the contract) of gross contributions.

This benefit is payable directly to the beneficiary of the contract upon the death of the insured person. If a beneficiary is named and the death benefit paid to him or her, there is no probate, executor, or legal fees.

7. Why seg funds appeal to senior investors This is of particular value when an investor is nearing, or has begun, retirement and cannot afford to lose in a volatile market any of the original capital invested. Even if the fund's actual unit value declined, your seg fund investment guarantees that you will get back a very high percentage of the initial capital invested, as agreed in the contract. At maturity, you will get back the guaranteed minimum amount or, if the market has risen in value, a higher amount. This means less worry, as you will know with certainty the minimum amount of money you will have when the contract matures (up to 100% of the original capital invested). This is particularly good for those who intend to pass the money on to the next generation if it is not needed for income or emergency during any period of market devaluation.

An example: An individual invests $2,000,000 in a seg fund that guarantees 100% of the capital at death. Assume this person dies just five years later, after a drop in the market that reduces the initial investment to $1,895,000. In this case, the full $2,000,000 investment would be paid as a death benefit. The capital protection feature would be a major safeguard for the preservation of the estate.

8. Avoiding probate fees Segregated fund policies offer a second estate planning benefit by allowing you to avoid costly probate fees. Depending on which province you live in, that can add up to a significant amount of money. Segregated fund policies allow you to designate one or more beneficiaries, much like a life insurance policy. At the time of your death, the proceeds from your seg policy are not included with the rest of your estate. The proceeds from your segregated fund policy pass directly to your beneficiary. The provisions of a seg fund contract, such as the guarantee periods and the MER, may be dependent on age and insurance underwriting. There are many new seg funds being developed offering various guarantees (and periods related to those guarantees). You should note that individual contracts have their own restrictions on the age to which you can invest. In addition, the level of payout can vary depending upon your age.

9. Creditor-proof investments Established under life insurance legislation, some seg fund policies might be protected from creditors for an investor's lifetime if the policyholder ever faced a lawsuit or bankruptcy. This is because seg funds include insurance-related contracts. There must be an irrevocable or preferred beneficiary (or multiple preferred beneficiaries)—a child, grandchild, parent, or spouse—named on the contract. This can be beneficial for self-employed small business owners who take more financial risk (such as consultants, dentists, lawyers, and accountants). Equally, since those who own a significant number of shares in a corporation or serve as an officer or director of a corporation may be liable if lawsuits are filed against that corporation, they also can benefit from this creditor protection. For example, a sexual harassment or environmental lawsuit could affect a small business owner or corporate officer. Losing a serious lawsuit can put both your business reserves and personal investments at risk.

Subject to certain restrictions, these strategies should be discussed with a qualified financial advisor. The creditor protection is allowed as long as money was not placed in the seg fund with the intent to protect the capital from an impending financial crisis. In most cases, however, the creditor protection is valid when the lawsuit or bankruptcy (in the case of both personal and business situations) is unexpected. Recent court rulings have shown that creditor protection may not always apply. You should seek legal advice to determine under what circumstances (especially intentional quick-fix shielding of money) a seg fund policy might not offer such protection.

What the higher expense pays for

The insurer holds a reserve in relation to the several guarantees provided in the policy contract. Due to market fluctuations, it is especially important that actuaries calculate and hold reserves needed to pay any future liability due to a capital loss. Because of the need to assess and insure the capital guaranteed, insurers must be involved. A slightly higher management expense ratio (MER) pays for these capital-conserving features; something we realize after the last Great Crash of 2007-2008. Typically, a segregated fund's MER will include 1-2% in relation to insurance costs. Nevertheless, for many investors, the cost of protecting a portfolio from capital loss is worth it.

Retirement planning advantage

Some seg fund policies allow for additional insured security, promising that a pre-established monthly payment of seg fund premiums (i.e., investments) will continue on your behalf in the event of a disability. Consider how valuable this pledge would be to your retirement if you could no longer work.

Seg funds are best suited for the investors involved in long term  wealth creation and preservation of capital

Capital protection appeals to a variety of people, including:

• everyday investors who are conservative and yet want higher returns than GICs offer;
• pre-retirees who need growth but can't afford to lose money;
• seniors who require estate protection and certain capital guarantees; and
• businesspeople who have exposure to personal liability and want to protect their assets.