The data behind soaring seg fund sales

Mutual funds and ETFs got plenty of attention for their record sales in 2021. While sales of segregated funds didn’t quite break records, they too soared last year. Some believe the increase was likely the result of regulatory arbitrage amid the ban on deferred sales charges (DSCs) for mutual funds. The evidence, however, says otherwise.

As with mutual funds and ETFs, the increase in seg fund sales reflected a stellar year of market performance. Based on data from Investor Economics, a division of ISS Market Intelligence, long-term investment fund net flows surged to $174 billion in 2021 compared to about $66 billion the previous year — an increase of about 164%. Mutual fund net sales alone increased by four times compared to 2020.

For seg funds, 2021 net flows tripled to $4.6 billion from $1.5 billion the previous year.

“Pretty much all products that provide market exposure were doing extremely well in terms of sales in 2021,” said Carlos Cardone, senior managing director with Investor Economics in Toronto.

Regarding seg funds, Cardone was unequivocal that the increase in sales wasn’t attributable to regulatory arbitrage: “There has never been anything in the data to indicate that [regulatory arbitrage] is happening in any way, shape or form,” he said.

The DSC ban for mutual funds was announced in 2019 and became official earlier this year, while a ban on DSCs for seg funds is expected next year. Insurance regulators are also consulting on a potential ban of upfront commissions.

Investor Economics research is based on detailed product data plus ongoing conversations with multiple industry stakeholders, including dealers, insurers, asset managers, heads of sales, wholesalers and advisors. Those conversations cover everything from fund allocations to business priorities to trends in fees and advisory practices, Cardone said.

While a substitution of flows to ETFs from mutual funds has been identified, no such effect has been identified with seg funds versus other funds, he said.

Many large dealers stopped new sales of DSC and low-load seg funds when they stopped those sales within mutual funds, Cardone noted. As a result, there’s been no rush by dual-licensed advisors to sell DSC seg funds. “Advisors … in many cases stopped doing business on that [DSC] basis,” he said.

The largest volume of seg fund gross sales last year came from advisors who were insurance-licensed only, said Guy Armstrong, executive director with Investor Economics in Toronto. Managing general agencies “that we spoke with indicated that most of their sales were from insurance advisors interested in providing market exposure to clients as markets advanced in 2020 and 2021,” Armstrong wrote in an email.

“Overall on-book segregated fund assets among independent financial advisor dealers (largely MFDA) dropped about 10% in 2020 and were relatively flat in 2021,” Armstrong wrote. He added that off-book activity — with the possible exception of deposits — at those dealers has been low, and so wouldn’t be a source of the increased seg fund sales.

Estate planning drives sales, but DSC ban drives advisors out

In addition to the 2021 story of market performance, a focus on estate planning helped drive seg fund sales.

Advisors’ use of seg funds for estate planning is “something that is trending big time,” Cardone said, and is a longer-term trend given that baby boomers are retiring and will be passing their wealth to the next generation. Estate planning was probably also boosted by clients’ increased awareness of their mortality arising from the pandemic.

Brian Shumak of Brian Shumak Financial Services in Toronto, who is insurance-licensed only, said his practice didn’t benefit from an influx of new money into seg funds last year, though he did get more inquiries about financial planning and estate planning despite his target market being under age 50.

He said he uses seg funds with small-business owners as a way to provide credit protection. When he learned of the dramatic increase in sales, he said his initial reaction was the knee-jerk one — that the increase was attributable to dual-licensed advisors who relied on DSCs now jumping to segregated funds.

However, last year’s increase in fund flows across the board resonated. “People were investing more — period,” Shumak said, noting increased pandemic savings. And the greater focus on estate planning makes sense due to demographics, firms’ promotion of estate planning and the potential increased awareness of mortality, he said.

While 2021 was an average sales year for Don Plettell of Plettell Financial & Estate Planning Ltd. in Lethbridge, Alta., Plettell said he’s increased his use of seg funds for estate planning over the last couple years, mostly for clients in their 80s with existing business in mutual funds.

Beyond the data, some advisors are “still selling as opposed to consulting,” Shumak said. “And if all you’re doing is selling, you want to take the path of least resistance.”

The DSC ban has resulted in fewer MFDA advisors in the financial advisor channel. The MFDA’s 2020 client research report said the number of advisors licensed with financial advisory firms (as opposed to banks and call centres) decreased by 17% from 2016 to 2019, largely because dealers prohibited sales of DSC funds (these outgoing advisors tended to have smaller books and relied on DSC fund sales).

More generally, as compliance requirements have increased, “those advisors that felt there was too much regulation on the mutual fund side of things dropped their mutual fund licence and sold [seg funds],” Plettell said. “I already saw that happen 10 years ago.” Some of these advisors were insurance advisors to begin with, he noted.

Ascertaining whether mutual fund regulations affected the number of insurance-only advisors is difficult.

For example, advisor turnover among many dealer firms in the advisory channel is very high “because of the nature of the independent model and the economic challenges that model imposes on advisors starting out,” Armstrong wrote. “Insurance-only licensees is an even larger cohort of advisors and not easily tracked.”

Plettell suggested that successful insurance advisors aren’t peddling product, and instead are planning for clients and paying attention to costs. Seg fund MERs can be similar to those of A-class mutual funds, he said.