While I understand the argument being put forward by Hargreaves Lansdown over the sale of with-profits bonds, I totally disagree with its view.
Hargreaves argues that if stockmarkets rise, life companies will use profits to boost their financial strength rather than pay all these profits to policyholders. In this case, Hargreaves should never have been recommending with-profits bonds, because this is how with-profits is supposed to work.
The idea is that, when stockmarkets perform well, investors do not get 100 per cent of the growth as some money is kept back in reserve to cater for the not-so-prosperous times. When stockmarkets perform badly, these reserves can be used so that investors do not suffer the full impact of the falls. This is called smoothing.
The smoothing process is why the financial reserves of life companies rise when markets are doing well and fall when they are doing badly. It is also why with-profits bond investors have not lost anything like as much money as those in unit-linked equity funds over the past couple of years.
The only way for investors to benefit from 100 per cent of the growth in the stockmarkets is to accept 100 per cent of the risks of the stockmarket. The typical with-profits bond investor is retired or approaching retirement and is likely to be relying on their bond to provide them with security in retirement. They often cannot or are not willing to accept direct investment in the markets and so suggesting a unit-linked equity investment as an alternative will often be inappropriate.
I would agree with Hargreaves that if an investor believes markets are going to fall further, they should not be putting money into any equity-linked investment at this time. On the same token, if they are too cautious to invest in equities, a logical alternative would be to keep their money on deposit or in guaranteed income bonds. With-profits bonds are not suitable for these people.
Yet, while I do not believe that with-profits bonds are suitable for all clients, they do still have a part to play for the right type of investor. I believe that this will continue to be the case as product providers are realising that they have to adapt their products for the 21st Century environment and the 21st Century investor.
At Chartwell, we still recommend with-profits bonds for some clients although with a proviso. We have only ever recommended bonds from the very strongest providers such as Prudential, Standard Life and Norwich Union. This is a stance we took when we began recommending with-profits bonds on the basis that the strongest companies would be able to prosper when stockmarkets were doing well and survive when they were doing badly. That remains the case today.
We do not recommend with-profits bonds because they pay high levels of commission. Our advisers work on a fee basis while on the discount side we sacrifice a minimum of 5.5 per cent commission to our clients. We recommend with-profits bonds if we think they are suitable investments – it is as simple as that.
Finally, Hargreaves states that it is unlikely that it would consider reintroducing with-profits bonds into new client portfolios for many years. Call me a sceptic but I wonder if Peter Hargreaves would fancy a little side bet on this?
Patrick Connolly is associate director at Chartwell Investment Management