With growth potential derived from a diversified asset range, helping to spread risk, the Norwich Union With-Profits fund answers an increasing customer demand for investments guaranteed to keep up with inflation investments.
In its recent Financial Risk Outlook the FSA said that survey evidence reveals that a majority of savers who do not buy investment products avoid them because of the risk posed to their capital. This reinforces our qualitative study into consumer understanding which found that, first and foremost, people want peace of mind and security. One of the biggest hits to savers in the past has been the impact on the purchasing power of their savings in high and mid inflation times. Coupled with the well-documented troubles of the stock market in recent years, it is no wonder customers continue to be attracted to those companies financially strong enough to provide valuable guarantees.
Norwich Union can offer a fund with real growth potential which includes investments in real assets that are more robust to inflation risks than fixed interest securities eg company shares and property. We also have the financial strength to support guarantees and effectively smooth returns to give investors some protection from downturns in the market. At no additional costs to the customer this fund offers (for a limited period only) a valuable inflation protected guarantee from the fifth anniversary onwards. The guarantee means the original investment will track the Retail Prices Index (RPI) and will therefore maintain its buying power after 5 years.
The growth potential of this fund is derived from a diversified range of assets, which helps spread the risk of investments.
The fund offers access to a wide range of assets including UK and international equities, government and corporate bonds, UK and European property, private equity and alternative investments.
So what kind of fund allows customers to access a wide range of diversified assets, the backing of a very financially strong company allowing the effective smoothing of returns, and a free cast-iron guarantee protecting capital against inflation - whatever happens in the markets (as long as money is left in the fund for at least 5 years from the start of the investment)?
The fund is the With-Profit fund provided by Norwich Union and the free guarantee is available (for a limited time only) to new investments into Portfolio, our single premium investment bond. At Norwich Union we firmly believe that with-profits offers great growth potential and should always be considered when choosing the key elements of an investment portfolio. We are so confident in the potential for growth through with-profits that we are fully prepared to use our financial strength to guarantee an inflation proofed return from 5 years onwards.
'This a strong fund within a strong company
and ultimately a strong group.'
AKG Open UK Life Office With-Profits Report
November 2005
In recent years the number of providers offering with-profits funds has declined, a trend that is likely to continue in 2006. The reasons behind closing a with-profits fund vary by provider and include a lack of financial strength or a change in business strategy, moving towards a less capital intensive product offering. With-profits continue to go through a difficult period and although application of market value reductions has reduced recently, payouts on longer term with-profits business continue to fall as the better performing years are replaced with the more recent lower performance of a slowly recovering market.
A change in regulatory requirements has also had its effects on providers who have had to reduce the equity content of their funds and/or introduce charges to cover the costs of guarantees. We have taken no such action on our main with-profits fund. The move towards a realistic reporting basis now requires companies to maintain an additional reserve (a Risk Capital Margin) to cover expected policyholder payouts, meet any guarantees the fund offers and also consider the likelihood of defaulting on bond investments and the risks surrounding that.
At Norwich Union, we believe in being open and transparent with our customers and have been a committed supporter of the Principles and Practices of Financial Management (PPFM) from the beginning. With-profits funds are complex and it's very important to us that we explain them as fully as possible to our customers. The PPFM outline the overarching standards we follow when managing our with-profits funds.
The financial strength of a company provides the foundation of its ability to support a with-profits fund. Without it, many companies have sought to provide customers with the protection they require via various alternative propositions. Structured products, including both closed and open-ended funds, and constant proportion portfolio insurance (CPPI) are a recognised feature of the UK life market and are now very much in fashion.
While derivatives and other financial instruments have been used now for many years to create guarantees and protection for tranche-based investments, the volumes for 2005 are estimated to be down on 2004 at around £4.9bn (source: structuredretailproducts.com). Growth products with a simple underlying index eg FTSE-100 now dominate the market. Income products are much more difficult to structure in a market with low volatility and in any case many advisers will be reluctant to return to the income market after the so-called precipice bond debacle.
The increasing complexity of structured product payout profiles has no doubt contributed to the decline in sales and a shift in distribution back to more traditional, open-ended investments. The key to successful structured product sales is simplicity and transparency. Products with a multitude of caveats and complicated payout structures involving unfamiliar indices, 'kick-outs' and 'cliquets' are unlikely to be attractive in a market which demands a greater level of customer understanding.
Open-ended protected funds on the other hand are a relatively new proposition in the UK market and as it appears to answer the demand for capital protection, such products are likely to take an increasing share of the investment market. CPPI was successfully launched into the market in 2003, but while 2004 and 2005 saw a great deal of provider activity in this area its difficult to see whether this has been matched by a corresponding increase in demand from consumers. The total market for open-ended protected products however, appears to be on the up (approximately £2bn in 2005 according to structuredretailproducts.com) with the inclusion of a large range of funds using derivatives rather than CPPI to create various levels of protection.
It should be noted, of course, that the protection offered by CPPI funds comes at a cost. The drag on performance within these funds comes from the three concepts inherent in this type of proposition. The most explicit is the higher management charge associated with these funds where an extra deduction is made to cover the cost of the gap risk, usually provided by a third party. Secondly there is the drag on performance when the fund holds a significant amount of the risk free asset eg in times of sustained volatility or after a significant fall in equities. Finally there are the additional transaction costs borne by the fund due to the formulaic re-balancing of assets in response to changing market conditions. Whilst meeting the customer's demands for protection, expectations around potential growth need to be carefully managed through a clear set of marketing material.
There are clearly many ways of meeting the increasing demand for guarantees and capital protection each with its advantages and disadvantages. Advisers and customers need to be able to weigh up the effects on price and drag on performance of any guarantees or protection offered. It must therefore be very difficult to ignore a cast iron, inflation protected guarantee where the cost to the customer is zero. We believe that with-profits, now more than ever, represents real value to customers. Our financial strength has allowed us to offer customers even more, demonstrating our commitment to delivering the best investment opportunities possible.
