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Sales or trails?

Norwich Union has set off a fierce industry debate by offering 20 per cent up-front commission on regular-contribution business into its invest- ment funds.

Cazalet Consulting principal Ned Cazalet says IFAs taking this commission would struggle to call themselves independent as it could lead them to promote funds that might be unsuitable for clients.

NU is aiming to increase its retail business share from 3 per cent to 5 per cent of the market by 2009.

Seven Investment Management director Justin Urquhart Stewart calls it an “eye-watering” level of commission but he believes the era of high front-end cash is coming to a close.

He says: “We are moving from sales to trails. This type of commission is going to be the exception rather than the rule. To the consumer, this high level of commission will look unacceptable and IFAs should be wary of that backlash.”

Urquhart Stewart says brokers will need to have clear and credible arguments on why clients should choose NU over other providers. He says IFAs will have to be careful to ensure the funds are sold in the right way. With the increasing push towards open architecture and transparency, he considers this type of product to be opaque and inflexible.

He says: “The mathematics of why we are selling it will stand up to an insurance industry viewpoint but to the man on the street it will look incredible. Sadly, I think we are still in a position where if you put out exciting chocolates people will eat them but they will end up feeling very ill in a few years time.”

Churchill Investments head of research Warren Perry says: “It smacks of desperation by the provider and any IFA that uses it. It is not about building a business but is about how they can get a quick profit.”

Perry says apart from NU’s property trust, the company’s fund performance has not been great.

He says: “Norwich Union are increasingly outsourcing their investment management to people like JP Morgan and Schroders, which tells you a lot about their performance.”

Perry does not think that many advisers who are looking to build long-term relationships with their clients will take up the NU offer.

But the deal has met with approval from some quarters. Chelsea Financial Services managing director Darius McDermott says the high up-front commission adds an extra level of flexibility for the adviser. He says he cannot imagine fee-based IFAs will like this type of commission structure and says it will only be attractive to certain sectors of the IFA community.

He says: “It is not a market-ing gimmick. We are talking about Norwich Union, which is one of the biggest life offices in the country. My positive comments are based on the fact that the up-front commission adds more flexibility for IFAs.”

With regard to Norwich Union’s fund performance, McDermott says NU has a top-performing property trust, a newly launched special situations fund (run by Schroders) and some new management which he says is starting to turn round its performance.

McDermott does not agree that it will promote bad practice among some quarters of the IFA community any more so than exists already.

He says: “I just do not see that argument. There are good IFAs and there are bad IFAs. It is down to the scruples of the individual adviser. But yes, I accept that you are more likely to be tempted by higher commission if you are a sales based IFA.”

In a survey by Money Marketing, when asked if brokers would write more investment business if providers paid indemnity commission on investment funds, 100 per cent of brokers said they would not. The comments received were generally not in favour of NU’s offering. David Kirkpatrick Associates principal David Kirkpatrick says: “It is a backward step. We are not commission-driven and these type of offers are potentially dangerous.”

J&H Kyle Insurance Consultants principal Jim Kyle says: “Anything like this that shows an increase in commission paid to advisers just means we have to go further out of our way to justify ourselves and it is not an incentive to do business.”

BestInvest business development manager Justin Modray fears that if NU proves to be successful that other providers may follow suit.

He says: “All providers essentially want to get more money under management but it is better all round if we move to trail commission due to the transparency of such structures.”

NU defends its position and says saying its treating customers fairly committee was heavily involved in the process. Sales director John Clougherty says the 20 per cent payment will mean that many small and medium-sized investors will get better advice from IFAs and more consumers will save regularly.

Clougherty says: “The IFAs we discussed it with were positive. We also discussed it at length with the FSA, who are OK with it because it does not alter the client’s fees.”

Property as has had many attractions as an asset class – low volatility, a lack of correlation to equity markets and the ability to provide a solid, reliable stream of income.

The past three years have seen another reason to invest in property – capital growth.

Returns from property normally fall somewhere between the lower figures for bonds and the higher ones from equities and on average this is around 7 per cent a year. The last three years however, have seen the average figure at somewhere closer to 20 per cent a year, outperforming all but the very best active equity investments.

The most recent figures from independent property analysts IPD show that in the in the last 12 months property has produced an enormous 21.3 per cent return, far ahead of bond performance and better than the 19.7 per cent that equi-ties returned over the period.

But this level of growth is unsustainable over the long term and investors looking to maintain this level of capital growth will be disappointed if they expect property to continue to provide such rapid gains.

Insight Investments head of external funds Philip Gadsden, says: “Markets do not do 20 per cent a year, year in year out, especially not with low inflation. We expect property to revert back to average returns of 7 or 8 per cent.”

Lucas Independent Financial Consulting managing director Mike Horseman says: “The levels of returns we have seen im the last three years, in the region of 18-20 per cent according to IPD, are unsustainable. We expect to see returns back in the region of 6 to 9 per cent.”

London and Country head of communications David Hollingsworth says the double-digit growth should not be relied upon for a fast return. He says: “With the residential market, short term is not the way to go with a buy-to-let investment. You should be looking at least to the medium term, if not the long term. To try to make a quick buck is not the best strategy.”

What are the options for property investors? Some analysts say growth is there for investors, with Europe, Asia and some sectors, such as central London offices, still offering gains.

Horseman says using a core satellite approach allows clients to invest more aggressively for growth. With 60-70 per cent of a client’s property investment in UK commercial property, the remainder can be invested more aggressively. He says: “Up to 30 per cent of investments can be put in satellite growth funds with exposure across the globe. If clients want to get exposure to growth areas, we are going to offer investments a bit further afield in markets such as Asia and Eastern Europe.”

Gadsden believes there are still short-term gains to be made in some UK sectors. He says: “Although the indus-trial sector tends to be the highest income-producing sector, the central London office market still offers some opportunities for growth.”

Gearing makes it possible to extract better returns from investments with lower returns but the possible downside does make this a high-risk approach.

ING Real Estate Investment Management managing director Simon Latham says: “There will always be opportunities to chase capital returns but they will become fewer and fewer as market returns fall.”

Horseman says: “Professional advisers need to get used to the idea of lower returns from property.”

Commercial property in the UK is likely to produce solid returns across the board and some experts say that rather than trying to pick sectors it is more important to ensure the underlying assets in the fund are sound.

Latham says: “If you are investing in an income fund, it is important to ask, what is the quality of the covenants supporting the income stream? And what is the longevity of the income stream?”

Residential property can be income-generating or a speculative investment, depending on the way that the loan is structured.

Professional investors who can to put down large sums of money and reduce gearing can still produce decent levels of income from the buy-to-let market but smaller investors borrowing large amounts may be unable to produce an income.


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