Re: The Game is surely up
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British media attention on With Profit funds is beginning to spill into Irish newspapers, and with billions at play, the debate aroused is no harm. But it’s important to separate important points from commercial agenda’s, especially when firms that lack the financial strength to compete in the sector, take a hand. With-profit funds invest in a diversified mix of assets including equities, fixed interest securities, property and cash. Much like any mixed fund the idea is to deliver competitive investment performance over the long-term. But there is one major difference. Actuarial science is used to give a smoothed return, ironing out the spikes and falls that naturally occur in asset values, to give a stable return. Critics of with-profits, quite correctly, point out that the arcane mixture of asset movements on the one hand and actuarial judgement calls on the other makes independent measurement impossible.
The ability of a life office to stretch its smoothing longer than others, covering the hole created during the current bear market, is ultimately a function of its financial strength. But measuring the strength of a life office is a difficult task, testing even credit rating agencies. This has largely to do with differences in how future liabilities are measured. Ultimately, the only person in a position to report on the precise position is the fund manager- hardly an independent source. Criticism of marketing and transparency is valid, but uninformed if it fails to recognise the intrinsic value of smoothed funds in financial planning, especially for retired investors seeking careful withdrawals to support lifestyle.
But, unhappily, unsustainable double digit yields on maturing policies sold during the 1970’s and 80’s has formed the centrepiece of marketing campaigns, painting with profit funds as some form of gravity defying equity based investment. In the Republic of Ireland alone over €1 billion poured in last year, a pattern repeated in the UK where over £15 billion was invested.
The success of a with-profit fund is not just a function of managing the underlying assets, but getting the smoothing right. Those with a commercial interest in criticising the with-profit sector focus on the likely shape of future smoothing, particularly when high annual bonuses are added despite large falls in underlying asset values. Postulations appear to be based on whatever assumed future asset growth helps the argument. But such analysis isn’t precise also because of the lack of disclosure characteristic of with-profit funds. Some funds, to protect long-term from short-term investors apply Market Value Reducers, as an early exit penalty. But the scale of MVR being applied may be an indication of the depth of falls in underlying asset values, exacerbated in one case by extra generous first year bonuses.
Still, in other cases, no MVR’s are currently applied. Standard Life whose AAA rating was recently renewed, and despite declines in its free asset ratio, has resolutely refused to apply MVR’s. But this is no guarantee that, in the face of any further stock market declines, MVR’s will not emerge at Europe’s largest mutual. Meanwhile, Eagle Star in Ireland, whose with-profit fund contains 60% in fixed interest securities, is also riding out the current bear market free of MVR’s. Last week Canada Life, a major player, announced the closure of its with-profit fund to new investment, reckoning that new investors would end up subsidising existing investors. But closing with-profit funds is not unexpected in bear markets, and shouldn’t be misinterpreted. Others may follow.
So, in the heat of debate how do you separate good from bad analysis. Firstly, ignore any scaremongering about solvency. Insolvency, a failure by a life office to meet with-profit guarantees, would require the loss of all free assets and a plummet through other thresholds including the required minimum margin, resilience reserves and further safety features built into the calculation of liabilities. Instead, expect (a) more with-profit funds to close for new business, (b) downward smoothing of bonus rates, and (c) reforms in the way in which information is provided. Ideally, investors should be have access to reports on the underlying fund value, its smoothed value and policy, its charges, and the cost of meeting guarantees.
When held over the long-term to maturity, with-profit investors should, reasonably experience returns in the range 2% to 4% above inflation. But it would be unwise to expect historic yields to be replicated. Maturing pension investments this year are recording yields over ten years ranging 9.5% to over 14% p.a., with similar yields for 15-year maturities. Longer term yields are higher, ranging from just under 13% p.a. to over 15% p.a. for 20-year maturities during which smoothing occurred during bear markets such as October 1987 and the Gulf War. Mark with-profit funds down as low risk, low return investments, whose smoothing provides the ideal environment for cautious income withdrawals to support lifestyle and you won’t be disappointed. But, expect with-profit funds to be an alternative to racy equity funds is a bit like expecting to win at the RDS, show jumping, on a camel.
Eddie Hobbs is a financial and management consultant, FDM, Summerhill House, The Curragh, Co. Kildare. Tel (045) 442051. E-mail
[email protected].
). How can companies claim it is as valid an offering as ever? Why doesn't the Regulator intervene and force them to follow CL's example?