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Out for the discount

Fund groups have slashed their spend on direct adverting following falling sales and the introduction of rules restricting the use of past performance. How much of an impact do you think this will have on groups&#39 direct business? Will discount brokers suffer as groups rein in their direct-offer spending?

McDermott: Fund groups&#39 direct business has gone down due to the advent of other platforms such as supermarkets and wraps but their reduction in direct advertising will also have an impact. I think the major factor is that the public do not like investing when they are losing money and, until the turn in markets last year, they had been losing money for the previous three to four years. Reduced advertising will naturally lead to a reduction in investor awareness.

Whitbread: Discount brokers are already feeling the after-effects of the loss of investor confidence after recent bear market conditions. Lack of advertising will add to this, as will restrictions on the use of performance data. Discount brokers will need to be more proactive in using their existing database effectively and look to new ways of generating new business.

Modray: It will no doubt have a negative impact on direct business as many investors have historically bought funds due to the selective attractive past performance figures displayed in glossy ads. Reduced advertising, coupled with rising interest rates, could mean investment groups experience a very quiet summer indeed.

Discount brokers will suffer too, as a proportion of their business usually comes from investors who make an investment decision based on fund manager ads and then shop around via discount brokers for a good deal. This is why brokers who discount while providing value-added services such as comprehensive research and advice, which builds client loyalty, are likely to fare much better than those who simply transact at low cost.

Schroders is launching a retail version of the fund of funds operation it runs with Standard & Poor&#39s. Although recent entrants to the Fof market have struggled, Schroders says it aims to become one of the major players in five to seven years time. Do you think this is achievable or has the market already become too cluttered?

McDermott: Like all parts of our industry, if a certain area looks promising for future sales you will see lots of groups launch products in that area. In the last two years, the area of interest has been fund of funds. I believe that market is already overcrowded and I can see little that excites me about the Schroders&#39 offering above the established players in that market.

Whitbread: Yes, there appears to be an element of jumping on the latest bandwagon here. Success of the operation will depend upon Schroders&#39 ability to focus in and sell to a target market. With Schroders largely marketing itself to discretionary players which do not typically have a strong inclination to fund of funds, this makes us question whether its existing supporters are a particularly appropriate marketplace for this new operation.

Modray: The market is cluttered and personally I am not a great fan of funds of funds. It seems to me that too many IFAs are using them as a copout, rather than investing the necessary time and resources to provide quality investment advice themselves. As a consumer, I would feel quite aggrieved by an IFA pocketing initial and renewal commission simply to stick my portfolio in some funds of funds, especially as I would end up paying yet another set of fees to a fund of funds manager.

The fact that some IFAs are required to use funds of funds by their professional indemnity insurers shows what a sad state our industry is in but it does mean that the market is probably growing for Schroders. It has a reasonable chance of succeeding.

According to ABI figures, with-profits bonds now account for less than 10 per cent of the single-premium life market. Less than two years ago, they made up 60 per cent. Do you think with-profits can ever make a comeback or has their stock fallen too low with IFAs and consumers?

McDermott: The first point to remember is that despite the best efforts of life offices there has been no clear replacement for with-profits. However, the concept of with-profits has been badly damaged and with some investors still facing a 20 per cent MVR penalty to withdraw their money, it would seem that the recent rally in the markets has not been passed on to policyholders, creating further negative PR.

Nevertheless, it does appear that stronger life offices, such as Norwich Union and Prudential remain supportive of with-profits and we watch their progress with interest in convincing a sceptical investing public.

Whitbread: We believe the chances of with-profits coming back to dominate the bond market, certainly in the short term, is about as likely as Tim Henman winning Wimbledon. Yes, there are still some stronger contenders in the market, with the likes of Pru and Norwich Union having commendable offerings. However investors&#39 appetite for with-profits has been so severely impaired that when you add this to a degree of market saturation for the sector, the future does not look positive.

Given that many of the with profits funds now have such small exposure to growth-orientated assets such as equities, the bonus rates over the next few years could also look lacklustre. Underlying returns are at lower levels than in the past and will also be used to bolster depleted reserves. If returns are poor, this will probably be the final straw, as greed overtakes fear and drives investors to look elsewhere for a home for their money.

Modray: I sincerely hope they do not make a comeback. The concept of smoothing is attractive in certain circumstances but, in reality, with-profits has proved to be an extremely opaque investment and has been used to power far too many commission-dri- ven investment vehicles.

Fortunately, consumers have wised up to an extent and are more wary of with-profits than in the past, but I am gobsmacked that some life companies are still trying to peddle with-profits via “enhanced commission” offers. Unfortunately, some advisers are still too naive or greedy to resist the lure of high commission, even though the product concerned has long since passed its sell-by date and is likely to be inappropriate for their clients.

Parents opening a stakeholder child trust fund will be banned from using investment trusts but permitted to invest in unit trusts. Do you think this is a mistake? Should investors have a fuller choice?

McDermott: We always support investor choice. However, with the ability to have gearing, you add an extra layer of risk and complication with investment trusts. I think the CTFs will offer a good range of choice, with equity, insurance and cash-based products looking likely to be available.

The main message that the industry needs to get across is that parents and grandparents should be encouraged to make additional payments to the plan.

Whitbread: In a perfect world, we would always advocate that investors should have maximum choice. However, when it comes to things such as stakeholder versions of the children&#39s trust fund, issues come into play in respect of the need for “basic advice” and “lifestyling” options, etc within a relatively simple investment structure. This probably rules out ITs – legitimately, I believe, especially given the FSA&#39s apparent enthusiasm for a filter system of questions to rule out unsuitable buyers. This, in my opinion, is impossible to apply.

Investment trusts are attractive vehicles and, in the right hands, can deliver strong returns for investors. However, the added complexities over open-ended funds – notably, I mean, discount volatility and gearing – would make them difficult to justify via the “stakeholder” route for the CTF for simplicity. On balance, it is probably best that the stakeholder range is kept as simple as possible, especially given the requirement for “lifestyling” within the product once the child reaches 13 years. The structure of ITs could make this rather difficult to achieve. For those who are keen to use investment trusts within the CTF, they will simply have to use one of the “authorised” options rather than a stakeholder plan so those who want a full choice can at least have access to it.

Modray: It would be nice to have a fuller choice but, in practice, this is probably not practical. The margins on CTFs will be low, giving advisers little inclination to advise, and I doubt that most CTF investors will want to stump up a fee for advice. This means that the majority of CTFs are likely to be bought execution-only, with the investor having made their own decision.

In general, I think it is unlikely that these investors will have the necessary know-ledge and skills to research investment trusts or understand the potentially higher risks involved compared with a unit trust. Even if advisers want to recommend CTFs, there is the issue that the FSA is not keen to unbundle commission. Unless this happens, then investment trusts will continue to struggle in gaining acceptance among advisers compared with unit trusts.

According to the IMA, net retail fund sales plummeted by 84 per cent from April to May. Given the largely insignificant Isa season, what do you think has caused sales to fall so dramatically? Do you think it will set a trend?

McDermott: We had a very good Isa season – by recent standards – so it was not a surprise to us that figures went down from April to May. After the Madrid bombings, the increasing trouble in Iraq, the rising oil price and interest rates going up, the markets became nervous again and so did investors. Having just had one good year for investment returns in four, the nervousness in the markets put clients off.

Whitbread: Low-risk alternatives such as deposit accounts/GIBs are looking much more attractive now; when you can get over 6 per cent gross AERs on GIBs why look at corporate bond funds where there is increased risk? Uncertainty of market conditions such as high oil prices, terrorist fears and the unrest in the Middle East have meant that people have a cautious outlook on equities in the short term. After a strong rebound since March 2003, equity markets have been struggling to gain any momentum during this year. The type of client who likes to invest only when things are going up is not doing much at the moment. There are also some investors out there taking profits from the last year&#39s investments. Summertime is typically quiet for equities and this year is looking like no exception. Rather than sitting indoors reviewing their portfolios, people are out there enjoying the sunshine and who can blame them?

Will it set a trend? Probably not. As soon as there is any sign of upward momentum, investors will start to become more active. Similarly, we would expect to see some action if markets fell back sharply. A correction is, after all, a great time to add to your portfolio but only the brave seem prepared to act.

Modray: Warm weather, football, rising interest rates, an uncertain economic outlook and a lack of confidence in financial services have caused many investors either to sit tight or withdraw investments. Investors like to invest when they can see a definite path ahead and feel they will not be missold to. In general they are struggling to do either at present. A sustained economic upturn will obviously help matters but the industry and the FSA also need to get their acts together and stamp out misselling. The simplest route to achieving this would be to ban initial commission and focus on reasonable ongoing commission or fees linked to the value of investments.

Darius McDermott,managing director,Chelsea Financial Services Sue Whitbread, director, Chartwell Investment Management

Justin Modray, business development manager,Best Invest


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