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Shorn of living pension

Zombie life funds have for years been a whipping boy for personal finance journalists, whether writing about pensions or any other with-profits investments. Their restrictions on investing in equities have made attacking investments in both closed and open with-profits funds like shooting fish in a barrel.

“Get out whenever you are offered a penalty-free window and move into a unit-linked pension with star fund managers” was the advice. But not for the first time in financial services, apathy will have served with-profits investors who ignored this advice well, as equities have floundered.

With-profits have come in for such a beating over the last decade it will come as a surprise to learn pensions investing in the products have performed better than their unit-linked counterparts over the last five and 10, and in some cases 15, years.

A survey in Money Management last month showed the average with-profits fund receiving regular contributions had returned an annual growth rate of 5.1 per cent over the last five years compared with a return of -1.5 per cent for balanced managed funds and -5.9 per cent for the average tracker. Over 10 years, all with-profits funds, except the one offered by Britannia Life, can boast positive returns on gross contributions – something many unit-linked policies would love to be able to claim.

The bad news is that most with-profits funds remain hamstrung by having little or no potential for outperformance through exposure to equities.

Even worse news for investors considering alternatives is that the equities that are supposed to drive long-term outperformance have failed to do so.

The underperformance of equities over the last decade has raised many questions about whether they should remain the central article of faith for long-term pension saving. This is hardly surprising, given we are at the bottom of the market.

Back in June 2003, when the FTSE was about where it is today, the FSA asked Pricewaterhouse-Coopers to consider revaluing its projection rates of 5, 7 and 9 per cent for long-term savings such as pensions and Isas.

Even then, amid the gloom of an investment community reeling from the collapse of the dotcom bubble and 9/11, PwC concluded that equities would be likely to outperform bonds in the long term. Its report said this outperformance, commonly referred to as the equity market risk premium, could reasonably be expected to be between 3 and 4 per cent a year. In light of this, the 5, 7 and 9 per cent projection rates remain to this day.

Equity supporters will point to this year’s Barclays Equity Gilt study. It confirmed that UK equities turned in negative annual returns of -1.5 per cent for the decade ending in December 2008. This was the 17th year ending a decade of negative returns since 1899. Not great news in itself, but it does mean there have been 92 years of positive 10-year returns.

While with-profits 10-year returns are good this year, the figures are a snapshot and a year or two from now the story may be different. I still feel that for many with-profits investors, getting out is a good idea, subject to the usual checks.

Today’s pension investors are facing doubts similar to those that led the FSA to undertake the 2003 PwC research in the first place. It would be a good idea if the FSA commissioned new research on the same issue to provide an unbiased estimate for the future of equities.

Otherwise, the tendency will be to leave zombie and other with-profits funds to continue staggering towards underfunded retirements.

John Greenwood is editor of Corporate AdviserMoney Marketing

50 Poland Street London W1F 7AX

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