Despite a positive year for investors, 2006 saw with-profits continue to struggle. Advisers are increasingly turning to the the unit-linked investment bond market, predicted to reach £3bn by 2010
Despite the sharp market corrections in May and June, the FTSE 100 ended the year 10.7% up, in what proved to be another positive year for many investors. However this didn't keep with-profits bonds out of the headlines as they continued to struggle to compete with the more advanced unit-linked investment bond sector.
The first with-profits bonus announcements are expected as early as mid-January. But already the Actuarial Profession is preparing to publish predictions that annual bonus levels will fall again this year despite strong stock market returns.
There are still many investors out there who are holding on to their with-profits policy in the hope that we will see a return to the days of healthy bonuses. But, as Patrick Connolly from JS&P Towry Law says: "I think the days of big bonuses are gone and it will be many years before they comeback, if ever."
As a result, some advisers are already reviewing clients' with-profits policies and many are turning to unit-linked investment bonds as a more advanced investment alternative. So what's the attraction with unit-linked investment bonds, and what should advisers look out for when selecting them?
Stormy weather
It's no coincidence that sales of unit-linked investment bonds rose significantly in 2003 - the year in which with-profits sales were in full scale decline.
In that year Market Value Reductions (MVR's) started to bite and bonuses continued to fall at most with-profits providers. In some cases bonuses fell from 3.3% to 1.7% between 2003 and 20051. In contrast, unit-linked investment bonds performed well, returning on average over 30% during the same period Lipper (ABI Cautious Managed Index ex initial charge).
The reason for this fall in bonus rates is clear. When stock markets started to fall, many with-profits funds were overweight in equities. Now many with-profits funds are underweight in equities which means they have not been able to capitalise on the last three-year equity bull run. As David Riddington of Norwich Union puts it: "Anyone with a high exposure to fixed-interest during this period (2006) will have done awfully."
And therein lies the problem. Because with-profits investors relinquished control of their asset allocation to the fund manager, and arguably the provider's actuarial department, they could not react to changing market conditions to maximise investment growth.
New horizons
With a unit-linked investment bond it's the adviser and the investor who control the investment. In fact the product features and benefits actually support the advice process.
That is because investors, with their adviser, have the opportunity to choose where they invest their money from a range of funds, so that they can tailor the asset allocation to suit their needs.
What is more, as the client's circumstances or the markets change over time, they can change their asset mix. This ability to switch funds not only helps the investor to remain in control of their investment plan, but it can also foster a closer working relationship with the client and encourages them to stay invested for the long term.
A clear choice
Clearly unit-linked investment bonds will play an important role in financial planning in this post with-profits world. We are already seeing a number of bonds positioning themselves as the natural successor to with-profits. In fact unit-linked investment bonds outstripped sales of with-profits by £1,595m in 2005, making up 71% of the total single premium life business.2
However, The Hartford believes that only those unit-linked investment bonds which are able to offer investment choice, plus innovative protection options, will be able to appeal to the widest audience.
These kinds of product features can offer more effective protection than with-profits 'smoothing'. That is because they can protect against falling markets and lock in gains when markets rise - as well as guarantee to repay up to 100% of the initial capital over time. As we head into an uncertain fifth year of the bull run, it doesn't take much to see how this could benefit more cautious clients.
Selecting a unit-linked investment bond
There are a number of unit-linked investment bonds in the marketplace, but when comparing and choosing the right bond for your client, things are not as straight forward as you might at first think.
Advisers should look for a provider that can offer a range of leading funds and fund managers, as well as cash and fixed interest. This range of funds should include a high proportion of actively managed funds, which tend to have higher charges.
Naturally there may be concerns about the effects of higher charges dragging down your client's performance, especially with lower equity returns widely predicted for the years ahead. However, research carried out by Fidelity has shown that funds across six key regions, all with higher charges, performed significantly better over a 10-year period than cheaper charging funds3.
As we have already touched upon, switching is an important product feature. This is not something you will normally find with a with-profits bond. However, switching will help you to maximise performance as markets change, as well as ensure the investment remains suitable as your client's needs change.
A fair comparison.
Staying with charges, another factor to look out for when selecting a unit-linked investment bond is the discrepancies within the different comparison tools. Because there is no standardised way in which providers supply information to financial data suppliers, it makes it difficult for IFAs to make an accurate comparison. This is because they cannot see if product providers have included all their product charges.
At The Hartford we believe in transparency and that the clearest way to determine the effect of charges and expenses is to compare the reduction in yield. That way you can take into account all the product charges including commissions, expenses, surrender penalties and adjustments.
Projected outlook
In the last five years we have witnessed an enormous shift in the investment landscape here in the UK. Today advisers are looking beyond more traditional investments to satisfy their clients' requirements. Clients will no longer accept a marriage of convenience. Instead they are looking for flexible investment solutions that include choice and transparency.
With this trend in mind, Datamonitor forecasts that unit-linked new business will grow at a compound annual rate of 12% per year. This would mean that we see levels of new business grow from £1.6bn in 2005, to just over £3bn in 20104, providing advisers with a significant opportunity.
We recognise that unit-linked investment bonds will not suit every investor. However, more and more advisers are seeing the benefits of holding a unit-linked investment bond in a client's portfolio.
1 Clerical Medical with-profits 2003-05 (FT Money 06 Jan 07)
2 Datamonitor May 2006
3 Fidelity 'Performance Matters' Sept 2006
4 Datamonitor May 2006
