Advisers urged to comfort investors with a little TLP

The fund industry has frequently discussed alternatives to with-profits investments. Over the past couple of years many fund management groups have launched products that they claim to be a perfect alternative to the much troubled with-profits funds.

So far most funds presented as alternatives to with-profits have invested in several asset classes. But according to a recent report by Merlin Stone of the Bristol Business School, American-issued traded life policies (TLPs) may be the answer.

TLPs — also referred to as life settlement policies — are whole-of-life policies that are sold before their maturity date. According to the Stone report, commissioned by Managing Partners Limited (MPL), the TLP market is increasingly popular among both retail and institutional investors.

About $50m (£24.6m) of life policies were traded in 1990, according to Bernstein Capital. By 2006 Credit Suisse reported that this had grown to $20 billion. The Stone report predicts the figure will rise further. Indeed, MPL reports that in the first eight months of 2007, 80% more retail investment money flowed into its TLP funds than in the same period last year. EEA Fund Management, which also manages a life settlement fund, says it, too, has seen a marked increase in its Life Settlement fund since its launch at the end of 2005.

Stone says the benefit of TLP funds is that they offer close to a guaranteed return. This is because of the certainty that the insured will die at some stage and the fact that the policy has a definite, nominal value. Together these factors make financial institutions willing to lend money to both TLP funds and their investors. “This potential to borrow to invest, or gearing an investment, makes TLP funds attractive to UK investors stuck in with-profits funds,” says Stone.

He adds: “Such investors, ever more disillusioned by their diminishing returns, can go some way to making up for the hefty surrender penalties they pay for pulling out of with-profits funds by using gearing to enhance their potential for higher returns. TLP funds will also continue to give them the steady predictable returns they sought from with-profits funds.”

John Buttress, sales and marketing director of the EEA Life Settlement fund, says it does not market the fund as an alternative to with-profits. He says what is key is that the asset class is not correlated to either equity or fixed-income markets. If anything, he says, TLP funds could be seen as an alternative to fixed-income funds. Indeed, according to the Stone report, throughout the turbulence in equity and credit markets this summer TLPs continued to deliver a yield of 7-9%.

The EEA Life Settlement fund targets annual growth of 8-10% net of fees, and Buttress says that in 2006 the fund achieved a return of 10.56%. He notes that the main risks in such funds are either that the fund is structured poorly or that people live longer than expected. In the EEA the average life expectancy in the fund is three years.

Despite the listed benefits of such funds, the report notes that if TLPs are to be a serious alternative to with-profits more has to be done to raise their profile among IFAs. According to research from MPL only 22% of IFAs are familiar with TLPs as investment products. One of the 78% not overly familiar with the asset class is Hargreaves Lansdown. Ben Yearsley, its senior investment manager, says: “When you look at TLPs they almost seem to be guaranteeing a profit. When something does this it always makes me slightly nervous, nothing is ever guaranteed.”

At this stage the firm is not recommending such funds, Yearsley says that before it does so, TLPs must demonstrate performance over the longer term. “We need to see how these funds fare over a full market cycle.”

Stone says the purpose of the report is to educate. At this stage, he suggests, with high interest rates affecting cash, property uncertain and shares close to peaking, investors should consider investing a quarter or a third of their portfolio in TLPs.

David Wynn, investment director at Bentley Jennison Financial Management, says more needs to be done to educate IFAs about the asset class. He says: “We have started looking at them, but not enough to have an educated view. We can see the appeal and we always look for uncorrelated assets as they are important for a truly diversified portfolio.

“At this stage we are open to persuasion, but we won’t advise anyone to invest until we understand what all the potential risks are.”