The U.S. electronic stock exchange of the National Association of Securities Dealers, better known as Nasdaq, has been dubbed "the stock market for the next 100 years." During 1998, the Nasdaq 100 index surged 85.3 per cent, and yet no regular mutual fund company can legally offer a Nasdaq 100 fund. Fortunately the same isn't true of segregated fund firms.
The index is made up of 100 stocks and reflects Nasdaq's largest growth companies across major industry groups, including major players in high technology, airlines, department stores, retail and health care.
By far the largest part of the index -- more than 60 per cent -- is made up of five stocks: Microsoft Corp., Intel Corp., Cisco Systems Inc., MCI Worldcom and Dell Computer Corp. As a result, mutual fund companies can't offer a 100 index fund, as they will end up with more than 10 per cent of their assets invested in one firm, which is against the law.
No such restrictions apply to seg funds, however, and two companies have taken advantage of this loophole. Transamerica Corp. offers the Growsafe U.S. 21st Century Index Fund and NN Financial has the Can-Daq 100 Fund.
Why should investors be so interested in these Nasdaq funds? It's simply an issue of numbers. The Nasdaq 100 index has outperformed all other major U.S. and international indexes over the past 10 years, and chalked up returns of 40.2 per cent in 1996, and 22.8 per cent in 1997 in addition to last year's astonishing number.
The companies that make up the index are the high-tech innovators, leaders, suppliers and distributors that are powering the current information and Internet revolution. Few analysts dare to cast doubt on Nasdaq's ability to sustain its phenomenal returns.
It's true that Canadian investors can already buy a range of diversified science and technology funds. But the Nasdaq 100 index has been much stronger than these actively managed funds, which averaged a return of 41.4 per cent last year. Actively managed funds may engage in trading during periods of volatility and sometimes miss out on a rapid market recovery.
But the most important difference is that no mutual fund, unlike the 100 index, could ever hold a 24-per-cent position in Microsoft -- the industry rules do not allow it. A seg fund that tracks the Nasdaq 100 index is, in essence, circumventing the rules in a big way, by legally holding gigantic positions in Microsoft and Intel, two of the fastest-growing stocks in the past few years.
Additionally, the Nasdaq index uses very stringent requirements for listing in this select list of 100 stocks, and the weighting is based on performance -- investors not only end up with the best stocks, but also get more exposure to the better-performing ones.
So how can investors get their hands on these superstar seg funds? Both funds are sold through a large network of insurance-licenced financial planners and brokers, like ScotiaMcLeod Inc., Nesbitt Burns Inc., TD Evergreen, RBC Dominion Securities Inc., and many more. Like certain other segregated funds, the two funds can both be purchased with 100-per-cent capital guarantees of the original investment at maturity, which is 10 years after the date of deposit.
Even more exciting is the fact that both funds are 100-per-cent RRSP-eligible, because they use futures contracts to mimic the performance of the 100 index. The only drawback is that investors have to hold these funds in a separate account as insurance contracts -- it is not possible, for example, to roll them into a self-directed RRSP with other regular mutual funds.
However, an investment in the funds can still be part of "the big picture" as a component of an RRSP. The Growsafe fund has a minimum investment of $1,000 and a very low MER of 2.13 per cent.
The company allows investors to freeze, or reset, the guaranteed amount at any time during the year, and as many times as they want, with no penalty.
Dan Hallett, an analyst for FundMonitor.com, says he wouldn't hesitate to recommend this fund to investors seeking growth potential and the safety of a guaranteed principal. The fund returned an impressive 93.6 per cent during 1998.
The NN Can-Daq 100 fund is offered with two options: a 75-per-cent guarantee of the original investment at no extra cost above the usual management expense ratio of 2.73 per cent, or a premium-based 100-per-cent guarantee, payable each trimester. The premium varies, but the last payment tallied in at 0.1875 per cent of the amount invested (which translates to roughly half a per cent a year).
This fund's return was lower than Growsafe's last year, coming in at 78.3 per cent. Disparities between fund returns and the index occur because of the way managers roll over their futures contracts and, more importantly, because of currency exposure. Growsafe's returns are not hedged against currency fluctuations and therefore have benefited from the recent fall in the Canadian dollar against its U.S. counterpart.
It's certainly the case that Nasdaq stocks are often more volatile than the average U.S. security. However, the Nasdaq 100 has historically provided a sufficient amount of reward to justify the risks.
The NN and Growsafe funds are tied into a sector of the economy that is strategically positioned to benefit from the innovations and expansion of the global information-based economy. They shake up preconceived ideas about seg funds being boring investments, and could seriously supercharge a fund portfolio.
The authors are the editors of the Fund Counsel newsletter (http://www.fundcounsel.com)