December 4, 2015    3 minute read

Segregated Funds: An Alternative to Bond Investments

   December 4, 2015    3 minute read

Segregated Funds: An Alternative to Bond Investments

Since the QE programme began, the United States has been able to grow at a steady pace, as it continues to get its economy back on track. This year, the third quarter registered a GDP growth of 2.1%, leading to an expected 2.5% for 2015, in line with the last few years. Pair that with an unemployment rate of 5%, and you get what looks like a full recovery. It is a well-known fact that the Federal Reserve is expected to raise short-term rates after a long period of keeping them near zero. Actually, this news is almost monopolising the attention of investor’s and finance aficionados around the world.

Europe is also to make a move as well. Not only it is not expected to follow the U.S. by hiking rates, but also to take the completely opposite route, by further committing to its Quantitative Easing. Unlike their American peers, European central bankers still cannot see the light at the end of the tunnel: minimal inflation and an aggregate growth rate of 0.3% for Q3, missing expectations by 0.1%, will prolong the negative rates scenario.

So, with low and even negative rates continuing to be the norm, is there any “safe” alternative to bond investments able to grant a “decent” remuneration? Depending on the definition of “decent”, the answer is yes.

The segregated fund

These products are linked to life insurance policies, and reinvest premiums collected from policyholders into the markets. Typically, Italian insurers sell them and their regulation is publicly available. So, where is the catch? Aren’t they just another kind of investment fund? Not really, they are called segregated for a reason: They are completely kept apart from the company’s balance sheet and, if the insurer defaults, the investor will still get all his money back.

Protection from creditors is great, but that is not the only benefit. The aforementioned funds invest and disinvest all assets at their book value, instead of using their market value. Asset classes can range between all of the available ones on the market but usually, the main component is high quality government bonds. Since they are valued at their book value, they do not suffer from interest rate risk.

Another great feature is that of minimum guarantees. In fact, they usually offer either a minimum annual return guarantee or a maturity guarantee.

Not only can segregated funds can offer protection, but also they grant competitive returns. During the last few years, demand for these products has been high, and their average annual returns are over those of the 10-year Italian BTP. Italian long term debt is the main benchmark, given the conservative asset allocation of segregated funds and the fact that they have nearly identical durations.

Let us look at figures comparing gross yields from GESAV (one of the first Italian segregated funds) and 10-year Italian bonds up to end of June 2015:
ImmagineOn the one hand, passive investors looking for capital appreciation while still achieving a good level of protection would find it a great alternative to government debt. On the other hand, an active and experienced investor should still pursue a more tactical asset allocation.

In conclusion, it can be seen that, especially in the current low rate environment, they are an attractive investment if compared to one of the most classical “safe bets”.

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