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Bonds in a bind

A bit like the agent of an aging actor or a fading pop star, providers of with-profits bonds are having to come to terms with the reality that their main act is diminishing in popularity.

With-profits bonds have been for long the popular choice for the low-risk investor seeking some equity exposure but the last couple of years have seen a massive fall in the volume of WP bonds being sold by IFAs and other distribution channels. From a peak of almost £15bn of new sales in 2001, sales in the last year have collapsed, leaving a big hole in the new business data for providers and in the revenue data for IFAs.

The reasons for the fall are many but most tend to be either a direct or indirect consequence of the sustained bear market through 2001 and 2002.

Some point to the crushing impact of market value reductions as the key driver while others believe the entire paternalistic concept is dead and some feel that the need for life offices to rebuild reserves will result in lower returns for the next few years.

The one thing that does seem certain is that the product has an uncertain future. That is not to say that the market will die, rather that it is unlikely to recover to the stage where we see sales at the kind of levels that were delivered in 1999/2000.

The emerging consensus is that the product needs of the typical target investors will be satisfied by a portfolio of products that may include with-profits bonds but which will also encompass structured products, possibly next-generation with-profits bonds and more modern, transparent solutions such as constant proportion portfolio insurance-driven funds.

All these products to a greater or lesser degree allow investors to alleviate or avoid the perceived (and actual)difficulties facing the with-profits asset class.

After the Equitable Life debacle, the widespread introduction of market value reductions on with-profits bonds has served to remind investors that what they see may not always be what they get.

This has helped fuel the media backlash against the asset class. It is easy to pick holes in much of the media commentary but it is also difficult to ignore the reality that such swingeing cuts in policy values does affect consumer confidence in the product, regardless of the reason for the cuts. Policyholders became concerned about the level of trust they could put in institutions and it is not difficult to see why sales have fallen so dramatically.

This leads into the concern over paternalism. In the past, when equity markets were racing ahead, investors seemed content with a one-size-fits-all approach to the management of their assets. Something was undoubtedly being lost in this pooled approach but the absolute returns were such that no one seemed to care. Now that we have seen a marked downturn in the fortunes of global equity markets, there is a renewed focus on risk and reward and, crucially, at a personal level.

There is also a greater understanding that it is not possible to provide everything with one asset class. The all too widely perceived with-profits proposition – the upside of the stockmarket with the security of cash – is now correctly understood as the mantra of a mad investor. IFAs and clients now have a far greater appreciation of the reality.

The third key reason for the demise of the market is the need for life offices to rebuild reserves. Free-asset ratios of some life offices have fallen by more than 80 per cent in the market downturn. FARs are a crude measure of financial strength and ability to meet future liabilities and while the decreases are not critical for the security of clients&#39 assets and future prospects, they do suggest that the top priority for some companies at least will be to rebuild their reserves if we should see a sustained market upturn.

There are no credible numbers so far to demonstrate this trend but it is difficult to argue with the general principle, particularly with new solvency regulations approaching on the horizon.

It is not all bad news for with-profits but it does seem that the sector will continue to trade under a cloud for the foreseeable future and certainly cannot be relied on to provide IFAs with the revenues being experienced just a few years ago.

Looking a little further ahead, providers should be aware that there are not that many which regain respectability and far fewer which make it back up to the top again.

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