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Cash points

Many product providers admit that they do not know if their equity-based investment products can beat cash deposit accounts.

Standard Life and Prudential were unable to say whether their equity-based with-profits funds would beat the 5 per cent plus being offered by many cash deposit accounts.

Some IFAs have started steering their clients away from equity-based investments and into lower-risk savings accounts.

Investment specialists from Bates Investment Services and BestInvest have backed up criticism of many equity funds dished out by independent consultant Ned Cazalet.

They believe that cash deposit accounts can be the best option for low-risk investors, particularly those looking to invest in the short term.

Standard Life managing director of life and pensions John Gill admits that the margin between cash and equities had narrowed and that it was “impossible to say” which would perform better.

He says: “Yes, cash is performing well. It is a difficult situation. I would like to say that a sensibly priced with-profits product could outperform cash but I can&#39t.”

The PruFund growth fund offers a 5 per return that it cannot guarantee but 5 per cent would not beat a number of cash deposit accounts and the fund could mean additional tax liability when it is cashed in.

Last week, Cazalet hit out at equity-based investments as a viable long-term vehicle since the markets had become increasingly volatile and trendless. This has led to risk increasing and returns falling.

He pointed to the poor performance of with-profits and the failure of split caps and precipice bonds as examples of investment firms trying to wring good returns from bad markets.

Bates Investment Services senior investment adviser Paul Illot admits that individual client needs and risk aversity are crucially important in deciding whether to take on equity investments. But he pointed out that while a deposit account may pay 5 per cent, this could be reduced to 3 per cent for a high-earner once tax had been deducted.

He says the benefit of a managed equity fund is that gains could be offset against the capital gains allowance.

Illot emphasises that a balanced portfolio is encouraged by IFAs since this steadies returns and keeping some cash in a portfolio builds in liquidity.

Illot says: “The problems with with-profits, as far as I can guess, is that they are fully benchmarked away. If you have a standard equity investment, then it is important that you do not follow the benchmark and look at the individual returns of a fund.

“When you look at some of the rates offered by deposit accounts, it is easy to see why they are a safe investment but it does depend on your individual tax position.”

Cazalet claims that with falling equity returns, increased market volatility and product providers&#39 inability to charge within the 1 per cent cap question the attractiveness and shelf-life of such products when investors can get over 5 per cent for cash held on deposit.

He argues that investment returns have been compressed to such an extent that the advantage of holding equities over gilts has now gone. Equity markets have been trending down to a 6 per cent a year return in line with average performance over the past 100 years.

The problem, he believes, is that life offices are looking to maintain equity exposure within their with-profits vehicles in a bid to provide better returns but are failing to achieve this because fully hedging an equity portfolio can cost a with-profits fund up to 6-7 per cent of its return annually.

Among the top deposit accounts are Alliance & Leicester which offers monthly interest of 5.37 per cent on its Premier Plus Current account, Capital One Savings gives 5.25 per cent, Northern Rock 5.22 per cent and Chelsea Building Society offers 5.25 per cent.

Figures from actuarial consultancy Watson Wyatt show that the majority of with-profits schemes from leading life insurers have returned well below this level.

Data from the end of 2002 reveals that AMP NPI had an annual bonus rate of 5.5 per cent while Axa was 3.75 per cent, Scottish Life 3.25 per cent, Norwich Union 4.75 per cent, Prudential 4.25 per cent and Standard Life 5 per cent.

But the Watson Wyatt data seems to point to an argument contrary to Cazalet&#39s.

It shows how over the same periods of time the median returns of with-profits funds would still have outperformed cash held on deposit in a building society. For instance, going back over three years, a with-profits fund would have returned 4.8 per cent while a building society account would give 3.9 per cent.

Over the last five years, a with-profits fund gives 4.9 per cent and building society 4.4 per cent while over 10 years with-profits returns 7.2 per cent and building society 5.1 per cent.

But a look at the median performance of managed funds shows a marked contrast.The return over three years is -18.9 per cent, over five years -11.3 per cent and over 10 years -1.3 per cent.

Watson Wyatt notes that the reason for this outperformance from with-profits funds is due to providers using reserves built up – and potential future returns – to declare a higher annual bonus that the actual returns achieved.

BestInvest investment adviser Justin Modray says:”In many ways, Cazalet is right. Why bother taking on the risk of a product that is based around equities when you can get exceptionally low risk and a better return from a cash deposit account?

“Generally, if people come into us and they only want to invest for three to five years, then we would recommend a deposit account.

“In recent years, the returns from with-profits funds have been disappointing. The annual bonus was always set at about the level of a bank deposit account but it was the terminal bonus where the real sugar was. That has been whittled away and pays very little or in some cases nothing so the attraction of holding with-profits has diminished with it.”

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