With-profits trap can be sprung

The exodus from with-profits funds looks to be far from over, as the vast majority of advisers say they are still planning to recommend their clients transfer their assets to other vehicles.

With-profits funds have taken up much space in the press over recent months and, as some of these opaque and complex funds continue to disappoint a number of investors, the interest in reviewing them is likely to continue.

Although many advisers have already moved their clients away from with-profits funds, research from Skandia shows that the exodus is far from over. A staggering 93% of the almost 500 advisers polled say they are likely to actively recommend that their clients transfer bond investments from with-profits to unit-linked funds within the next 12 months.

That is not to say, however, that moving this money is a quick and easy task – especially for advisers with considerable numbers of clients on their books invested in with-profits funds. Each client needs to be evaluated individually so that the most appropriate advice can be given, specific to the fund in question. Having gone through a review process, it may not be in a client’s best interests to move, as they may have valuable guarantees or benefits that would be lost on surrender.

With-profits funds come in all shapes and sizes, with some in good health and some not. With this in mind, the need to carry out a review is clear.

Advisers facing this substantial workload need to look to initiate an efficient, repeatable process for dealing with each case that will ensure every client gets the attention they deserve, appropriate advice and that nothing is missed.

In the first instance, there are three major factors to look at: the client’s investment objective and time horizon; their attitude to risk; and their tax position. Although with-profits funds are now generally considered to be out of favour, not all have failed to live up to expectations. To tackle the problem advisers may find it helpful to use a step-by-step action plan to conduct the client review.

The first step is to identify relevant clients. Advisers may want to consider reviewing their entire book of clients to see who holds a with-profits investment. Those with large numbers of clients affected may want to prioritise. Clients with policies that have Market Value Reduction-free anniversary dates approaching are likely to come top of the list, followed by those in funds with an asset allocation that no longer matches their attitude to risk – for example, a number of closed funds. Some may no longer match the growth expectations of the client and there will be some with other changing circumstances that have meant the policy no longer meets their needs.

A good decision can only be made if it is well-informed, so the next step for advisers is to get hold of up-to-date information. There are a lot of questions to be asked and detail is needed on many points such as guarantees and options that might be lost on surrender – for example, life policy benefits – and whether there are any MVR-free exit points.

The adviser needs to understand the current asset mix and future performance potential – and what the prospects are for the fund moving forward, taking into consideration any restrictions on investing in equities. The cost of surrender is also crucial, including any penalties and MVRs that may occur, or the loss of future windfalls, and the cost of a replacement policy including any life cover.

With this information, advisers will then be in a position to decide what action is needed. For this stage of the review, further information needs to be gathered on the implications of a transfer. In a replacement policy, would the asset mix better match the risk profile and investment objectives of the client now and in the future?

Assessing how important it is for the client to have control over the asset mix will also affect the choice of product to transfer to. The costs of a replacement policy should be taken into account, including set-up costs, whether the entire fund value can be transferred, any tax implications, and replacement costs for any life cover.

The chance then comes to talk through the situation with the client and present a range of options, which may include a number of possible alternatives to their current with-profits investment. At this final step in the review process, those clients who may have felt condemned to a with-profits investment that no longer meets their needs may be offered a ray of hope.

By following this process, advisers will be well positioned to make sure they can offer informed advice and the client is best placed to make an informed decision – whether that is to stay in their with-profits fund or to leave and invest in a suitable alternative.

Given the feedback from advisers, it is likely that in many cases the recommendation will be made to move away from with-profits. There is an enormous choice for advisers when considering where they move the money. One of the principle benefits of moving out of with-profits is that control over investment choice can be restored.

By transferring to unit-linked investments, advisers can go through all the steps to make sure the client’s investment portfolio is tailor-made according to their needs at the outset, and then reviewed on a regular basis, rather than the client having to settle for what might be a less than satisfactory, one-size-fits-all portfolio. An adviser may consider recommending individual fund selection or a multi-manager approach, again depending on what is most suitable for the client.

There is no doubt that a significant opportunity exists for advisers to review and look to improve the longer-term prospects for some clients invested in with-profits investments. Some consider this to be a with-profits trap, but the good news is that it does not necessarily need to be a trap after all.

With-profit sales