Are with-profit funds worth it?
In recent years, with-profits funds have become something of a black sheep in the investment world. Disappointing performance and dwindling returns have left many endowment holders unable to repay their mortgages, while those who used the funds as part of their pension planning are retiring on much less than they had anticipated. To make matters worse, the risks associated with investing in with-profits were not adequately explained to many investors, and insurers across the industry have been fined for mis-selling.
Yet, despite the tarnished reputation of with-profits funds, providers seem to be enjoying a revival, with sales soaring over the past year.
Prudential, for example, has reported sales of £48 million during the first six months of this year – up a whopping 182% on the same period in 2007. It’s a similar story over at Legal & General where sales are up 133% for the first half of the year, while Norwich Union has enjoyed an uptick of about 50%. These are impressive figures by anyone’s standards.
So why is this happening? Is it because with-profits are genuinely attractive products or do financial advisers have ulterior motives for recommending them to clients?
Darragh Leeson, a spokesman for Prudential, attributes the dramatic rise to investors searching for a safer haven in volatile market conditions. “Clients and advisers are looking for ways to protect themselves from the risks associated with investing in markets at the moment.”
He suggests that exposure to a diverse range of asset classes, including private equity and commercial property, skilled management and the ability to smooth returns are behind the boom in popularity.
But not all providers are quite so enthused. John Perks, customer solutions director at LV=, says sales with his friendly society have been pretty flat. “We’re not actively pushing with-profits funds in the same way as others because we’re not sure that’s exactly right for investors at present,” he says. “It’s up to the independent financial adviser to decide what they think is best for individual clients.”
Before we draw any conclusions, it’s important to understand the premise behind with-profits funds. The theory is sound: money is paid into a policy, where it’s pooled with the premiums of fellow policyholders and invested in a mix of equities, property and low-risk investments such as gilts.
The fund also protects investors from falls in the stockmarket by ‘smoothing out’ the level of returns. It does this by holding back some of the returns generated in the good years to pay out during the bad. These qualities made with-profits very attractive to people who wanted to either have a lump sum at a specific date in the future – principally endowments – or an income, along with the possibility of growth.
Unfortunately, as is often the case, the idea worked better in theory than in practice. A number of companies, including the infamous Equitable Life, made some fatal mistakes, such as investing too heavily in the stockmarket and paying out too much in bonuses. So, when the markets dived at the start of the century, triggered by the dramatic collapse of the over-hyped technology stocks, many with-profits funds found themselves in dire straits, and a sizeable number have failed to recover.
These funds, which were heavily invested in equities at the time, were forced to move into less risky investments in order to guarantee existing policyholders’ payments – which, in many cases, were overly generous.
Adding to the misery was the fact that the cautious new investment strategies employed since the problems took hold meant that most funds didn’t enjoy the benefits of exposure to soaring equity markets once they bounced back from rock bottom.
With many of the leading with-profit providers cutting their final bonuses by up to 10% since January, and several also introducing heft exit fees, policyholders are likely to face more misery. Many people are still complaining about with-profits policies. According to the Financial Ombudsman Service (FOS), there were 1,192 complaints about with-profits and unit-linked funds in the year to 31 March 2008.
The FOS annual report notes: “During the year, we have continued to receive complaints about so-called ‘market value reductions’ [a charge sometimes imposed by a provider on those leaving early] being applied to some with-profits bonds when consumers cash them in. We have also received a significant number of complaints about the failure of bonuses on with-profits bonds to reflect improved stockmarket conditions – and about the way with-profits bonds work, which some consumers believe is inherently unfair.”
Yet, despite these ongoing complaints and the sector’s rather chequered history, there appears to be no shortage of investors queuing up to get involved once more. So what do they find so attractive?
Mark Gregory, L&G’s managing director of with-profits, believes people like the fact they are buying into actively managed portfolios; are attracted by the idea of a smoothing process; and feel reassured about getting access to investment expertise. “There’s been renewed interest in with-profits for longer than some commentators may have realised,” he says. “We’re not back to the levels of the late 1990s, but there’s definitely been something of a renaissance in terms of investor interest.”
In fact, Gregory points out, the 133% sales increase recorded during the first half of 2008 is even more impressive when you consider that figures for the first six months of 2007 were themselves up 25% on the previous year. “The credible houses, such as L&G,
Prudential and Norwich Union, have become much clearer about their with-profits propositions,” he adds. “We are much more aware of the fact this is an investment being targeted at lower-risk investors.”
This situation bemuses Peter Hargreaves, co-founder of financial adviser Hargreaves Lansdown. He has even gone as far as to suggest that the bumper commission rates offered by product providers may be influencing some advisers’ decisions. He points out that the fact that it’s possible to get up to 7% for selling a with-profits fund, compared with a rather more modest 3% for the average unit trust, may well be a factor as far as some individuals are concerned.
“There’s no earthly reason why you’d buy with-profits funds at the moment, because the bonuses they’re paying are derisory, and they also pay a higher rate of capital gains tax,” he says. “A lot of them are also very exposed to commercial property.”
Despite enjoying double-digit returns for a number of years, commercial property funds are now struggling, with the average fund in the sector down by more than 20% over the past year.
In addition, Hargreaves adds, most with-profits funds are still desperately trying to replenish the reserves that became so badly depleted after the stockmarket fall of eight years ago – which means investors won’t be enjoying much upside, even in the good times.
“If the fund goes up 20% in value, the company might only give you between 5% and 6% because they’re still re-stocking their reserves like mad,” he explains. “It strikes me that this isn’t the right investment for people at the moment.”
If Hargreaves’ concerns about commission rates influencing advisers’ decisions are true, then it raises serious questions about the supposed impartiality of the advice being dispensed by independent financial advisers. It could also make them blind to the downsides of with-profits funds and set them on the road to a mis-selling scandal.
So what do other advisers make of the situation? Rob Robson, technical research manager at independent financial adviser Skipton Financial Services, is divided on the subject. While he believes there are good with-profits propositions available, he also suggests they won’t be suitable for everyone.
“There’s nothing wrong with with-profits as a concept, and there are some excellent funds out there in which we are recommending existing clients stay invested,” he says. “Also, if a client wants to invest in with-profits then that’s great, but as a company we’re not really active in this area anymore.”
But what if you already have a with-profits fund – should you stick with it or get rid of
it as soon as possible? To make a decision, you need to examine exactly what the product is offering, and seek professional advice.
As Andy Gadd, head of research at Lighthouse Group, points out, with-profits funds may be appropriate for certain individuals, but their suitability needs to be considered on a case-by-case basis. “Provided that with-profits funds meet the requirements of best advice, then I don’t believe that there’ll be another mis-selling scandal,” he says. “As long as the commission payments are fully disclosed before an investment is made, then it is for the client to determine whether or not they are reasonable.”
Geoff Penrice, an IFA with Bates Investment Services, adds that he hasn’t put new clients into with-profits for many years, but acknowledges they have a use for the right person. “Most of my existing with-profits clients are in the Prudential with-profits fund, and I haven’t advised them to move.”
But he emphasises that investors must be given the right information. “It’s important for both the client and the adviser that full justification is given for any advice – and that all the risks are clearly outlined.”
So, before you consider buying a slice of the with-profits market, make sure you’re doing it for the right reasons and not just helping to bump up your financial adviser’s pay cheque.
Review your with-profits fund
1. Ask your provider how much it’s worth – even though this will be just an estimate
2. Find out where your policy is invested. If it’s mainly in equities you will have a better chance of achieving your goals – but it will come with added risk
3. Check the small print of the policy. In particular, look to see if there are any dates on which you can exit without paying any surrender charges
4. Find out what benefits or guarantees are in place. You need to be clear about what you could potentially miss out on if you cashed in the policy
Have you been mis-sold a with-profit fund?
• You will need to give the company a chance to look into any complaints. Try to contact the person you originally dealt with. Failing that, ask for details of the official complaints procedure
• Put your complaint in writing, and keep a copy. If you do it over the phone, be sure to note down the names of everyone you speak to, along with the time and date of your call
• Be polite, calm and to the point. Set the facts out logically and send in copies of any relevant paperwork that supports your case
• If you’re not satisfied with the company’s response, then the Financial Ombudsman Service can look into the situation on your behalf. Call 0845 080 1800 or visit financial-ombudsman.org.uk for more information
The practice of a dishonest salesperson misrepresenting or misleading an investor about the characteristics of a product or service. For example, selling a person with no dependants a whole-of-life policy. There have been notable mis-selling scandals in the past, including endowment policies tied to mortgages, employees persuaded to leave final salary pensions in favour of money purchase pensions (which paid large commissions to salespeople) and payment protection insurance. There is no legal definition of mis-selling; rather the Financial Services Authority (FSA) issues clarifying guidelines and hopes companies comply with them.
With-profits funds are administered by life assurance companies and access to them is through the life company’s products such as bonds, endowments and pensions. Your monthly contributions are pooled with other investors’ money and invested in a mixture of shares, bonds, property and cash. Each year, a “reversionary” bonus (a declared percentage) is added to your investment and a large part of the policy’s final value depends on these bonuses during the investment period. In years when the with-profits fund performs well, some of the return is held back and paid out in years when the fund does badly and this “smoothing” process makes with-profits investments unique. When the policy matures, the life company may pay a discretionary “terminal bonus”.
A financial adviser who is not tied to any financial services company (such as a bank or insurance company) and is authorised by the Financial Services Authority (FSA). They can advise on financial products to suit your circumstances. All IFAs have to give consumers the choice of paying by fees or commission and have to explain which would best suit the customer in that particular instance. Also, if commission is paid either by the client or the financial service provider recommended by the IFA, the IFA must disclose what that commission is.
A collective investment vehicle (known in the US as a “mutual” or “pooled” fund) and similar to an Oeic and investment trust in that it manages financial securities on behalf of small investors who, by investing, pool their resources giving combined benefits of diversification and economies of scale. Investors buy “units” in the fund that have a proportional exposure to all the assets in the fund, and are bought and sold from the fund manager. The price of units is determined by the value of the assets in the fund and will rise or fall in line with the value of those assets. Like Oeics (but unlike investment trusts) unit trusts and are “open ended” funds, meaning that the size of each fund can vary according to supply and demand of the units form investors. Unit trusts have two prices; the higher “offer” price you pay to invest and the “bid” price, which is the lower price you receive when you sell. The difference between the two prices is commonly known as the bid/offer spread.
The familiar name given to securities issued by the British government and issued to raise money to bridge the gap between what the government spends and what it earns in tax revenue. Back in 1997, the entire stock of outstanding gilts was £275bn; by October 2010 it had surpassed £1,000bn. Gilts are issued throughout the year by the Debt Management Office and are essentially investment bonds backed by HM Treasury & Customs and considered a very safe investment because the British government has never defaulted on its debts and this security is reflected in the UK’s AAA-rating for its debt. Gilts work in a similar way to bonds and are another variant on fixed-income securities.
Capital gains tax
If you buy an asset – shares, a second home, arts and antiques – and then sell it at a later date and make a profit, that profit could be subject to CGT. You don’t pay CGT on selling your main home (which is why MPs “flipped” theirs so regularly) or any securities sheltered in an ISA. Individuals get an annual CGT allowance (£10,600 in 2010/2011) but if you have substantial assets it’s worth paying an accountant to sort it for you.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
If you’ve have a complaint about a financial service product you have bought but the company you bought it from refuses to resolve your problem after eight weeks, the Ombudsman can help. The Ombudsman will investigate and resolve the matter. The Ombudsman is independent and its service is free to consumers. The Ombudsman may find in the company’s favour but consumers don’t have accept its decision and are always free to go to court instead. But if they do accept an Ombudsman’s decision, it is binding both on them and on the business.
All limited liability companies registered in the UK are compelled by law to compile a report once a year on the company’s accounts and directors’ statements must be issued to shareholders and filed at Companies House. A report details a company’s activities throughout the preceding year and its contents will include chairman’s statement, auditor’s report and detailed financial information such as cash flow and balance sheet statements.