Mutual funds and ETFs were in high demand due to record sales in 2021. While sales of segregated funds did not break records, they also increased last year. Some believe that this increase was likely the result of regulatory arbitrage due to the ban on deferred sales charges (DSC) for mutual funds. However, the evidence says otherwise.
Similar to mutual funds and ETFs, growth in segmented fund sales reflected a strong year of market performance. Data from Investor Economics, a division of ISS Market Intelligence, showed that long-term mutual fund net flows rose to $174 billion in 2021 from about $66 billion the previous year, an increase of about 164%. Net sales of mutual funds alone quadrupled compared to 2020.
For seg funds, net flows tripled in 2021 to $4.6 billion from $1.5 billion in the prior year.
“Almost all products providing market exposure performed exceptionally well in terms of sales in 2021.” said Carlos Cardone, senior managing director at Investor Economics in Toronto.
As for segmented funds, Cardone was clear that the sales growth couldn’t be attributed to regulatory arbitrage: “There has never been anything in the data to indicate that (regulatory arbitrage) is occurring 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 the DSC ban for seg funds is expected to happen next year. Insurance regulators are also consulting on a potential ban on upfront commissions.
Investor Economics’ research is based on detailed product data and ongoing interviews with a range of industry stakeholders, including dealers, insurers, asset managers, sales executives, wholesalers and advisors. These conversations cover everything from funding allocation to business priorities to fee trends and advisory practices, Cardone said.
While substitution of flows into ETFs from mutual funds was identified, no such effect was found for seg funds compared to other funds, he said.
Cardone noted that many large dealers have paused new sales of DSC and low-load segment funds when they have paused those sales of mutual funds. As a result, dual-licensed advisors have been slow to sell DSC segmented funds. “Advisors… in many cases have stopped doing business on this (DSC) basis,” he said.
The largest gross sales volume of seg funds last year came from advisers with an insurance-only license, said Guy Armstrong, executive director of Investor Economics in Toronto. General agency managers “we spoke with indicated that the majority of their sales came from insurance advisors interested in providing clients with market exposure as markets develop in 2020 and 2021,” Armstrong wrote in an email.
“Overall, on-book fund assets distributed to independent financial advisors (primarily MFDAs) declined by approximately 10% in 2020 and remained relatively unchanged in 2021.” – wrote Armstrong. He added that off-the-book activity – with the possible exception of deposits – is low at these dealers and therefore would not be a source of increased sales of segment funds.
Estate planning drives sales, but DSC ban drives out advisors
In addition to 2021 market performance, a focus on estate planning helped drive segment fund sales.
Advisors’ use of seg funds for estate planning is “something that’s getting a lot of attention,” Cardone said, and it’s a long-term trend as baby boomers retire and pass on their wealth to the next generation. Estate planning was probably also supported by increased customer awareness of mortality resulting from the pandemic.
Brian Shumak of Brian Shumak Financial Services in Toronto, who is exclusively licensed in insurance, said his practice did not benefit from the influx of new money into segmented funds last year, although despite his expertise, he received more inquiries about financial planning and estate planning in the marketplace the target group are people under 50 years of age.
He said he uses seg funds in partnership with small business owners to provide credit protection. When he learned of the dramatic increase in sales, he said his first reaction was knee-jerk – that the increase could be attributed to dually licensed advisors who relied on DSCs, which are now moving to segregated funds.
However, last year’s increase in fund flows made a big splash. “People invested more, period,” Shumak said, noting increased savings related to the pandemic. A greater focus on estate planning makes sense because of demographics, companies promoting estate planning and the potential for 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 has increased his use of seg funds for estate planning over the past few years, primarily for clients in their 80s with existing activities in investment funds.
Beyond data, some advisors “are still selling, not consulting,” Shumak said. “And if all you do is sell, 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 Survey Report found that the number of advisors licensed by financial advisory firms (as opposed to banks and call centers) declined by 17% between 2016 and 2019, largely because dealers banned the sale of DSC funds ( these departing advisors tended to have smaller books of accounts and relied on the sale of DSC funds).
More generally, as compliance requirements increased, “those advisors who felt there was too much regulation on the mutual fund side of things ended up relicensing their mutual funds and selling them (segmented funds),” Plettell said. “I saw it 10 years ago.” He noted that some of these advisors were insurance advisors from the beginning.
Determining whether mutual fund regulations have impacted the number of insurance-only advisors is difficult.
For example, advisor turnover among many dealership firms in the advisor channel is very high “due to the nature of the independent model and the economic challenges this model imposes on entry-level advisors,” Armstrong wrote. “Insurance-only licensees are an even larger group of advisors that are difficult to track.”
Plettell suggested that successful insurance advisors don’t sell products, but plan for clients and pay attention to costs. He added that the MERs of segmented funds may be similar to Class A mutual funds.
