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Waiting for with-profits weightings

With-profits fund allocation is getting increasingly difficult and complicated considering the current market environment.

With the interim bonus reporting season coming in the next few months, it will be interesting to see what life companies announce. Considering their double-digit weightings in the highly illiquid commercial property market and the falls that asset class has seen, what will be equally interesting to see will be how the property holdings have affected overall performance. And who is valuing the holdings within the funds?

With hundreds of billions of pounds invested in with-profits products, the asset allocation mix, returns and bonus levels in with-profits are inevitably under scrutiny from policyholders and intermediaries – never more so then when it is bonus time and July marks the time when many life companies make interim statements.

In the not too distant past, with-profits took a beating from which it would seem that few have recovered in terms of investor sentiment. Although, by and large, market value reductions (MVRs) – in place since the bear market of 2000-03 – have waned, the current market turmoil is sure to bring this issue back to the front-burner.

Despite the bad press for with-profits, the drops in bonuses and the high MVRs that were imposed on these vehicles, with-profits returns held up reasonably well during the bear market, especially compared with pure equity unit-linked funds.

How they are functioning in the current market, though, remains to be seen, considering the long time lag in reporting with these funds.

One big issue for the funds is their weighting to commercial property. A safe haven for many of these multi-billion-pound portfolios during rough equity times, many with-profits moved to high double-digit weightings in the asset class in recent years. This may have served the funds well in 2002 but today it means they are stuck in a falling asset class that is difficult to adjust with any rapidity.

Consultant Ned Cazalet estimates with-profits hold collectively around £50bn in commercial property, with the average fund holding of 15-16 per cent, although he points out there are exceptions to this, with some funds featuring negligible weightings while others are much higher.

Standard Life reports that while some of its with-profits funds held as little as 9 per cent in property as at the end of the final quarter of 2007, other with-profits funds at the firm go as high as 20 per cent.

A Standard Life spokesman says: “There is a full-scale valuation of the with-profits fund at least once a year where we will use external experts. Between full valuations, our internal property experts take into account any relevant factors – for example, market sentiment, rental income, break clauses, etc.”

Outside of the impact on returns, another issue that the property positions in with-profits are creating is based on their relationship within the life companies.

Cazalet notes there has been concern and talk of the recycling of property holdings among life company funds but of greater concern, he thinks, is how these properties are being valued. Selling them on to other funds within a life company has been talked of but again, even with the ethics of this pushed aside, there remains the question at what and whose valuation are they being sold?

Estimates from econ-omists talk of commercial property falls of about 20 per cent but how much and who is valuing the individual holdings in the with-profits funds will largely determine the performance of the portfolio with property sitting at such high levels.

So what are with-profits holding then and what will this mean for the funds and for the market as a whole?

Cazalet says, in general, he has found with-profits are selling equities and on the whole are also selling bonds while the property weightings look static.

Considering the cashflow pressures of the sector, the obligation to policyholders and the fact that little new money is going into these funds places big questions over what life companies are doing with the asset allocation of the portfolios.

In a shrinking sector, good investment performance can aid the cashflow needed for maturing policies.

But good investment performance today is difficult enough to achieve in any of the mainstream asset classes in which these funds are invested. Equities and bonds can be sold as they are liquid positions but where does that leave funds invested?

The divestment by such big equity and bond holders will not help the overall market situation either.

With-profits could sell their commercial property holdings but selling into a soft market is not a great option for commercial property holders and while unilinked funds have been able to postpone forced selling through delayed redemptions, how with-profits deal with it is another matter.

Even if property positions are sold down, likely at loss, then can these funds ever regain positions in the asset class again? Holding on to the positions may be the prudent choice for most, especially considering the attractive yields that properties still possess, even if the capital values are falling.

However, holding on may again force asset allocation changes in other areas.

The issue is not whether with-profits are going to get a beating in perform-ance terms, nor that the market should be prepared for another raft of high MVRs and non-existent bonuses, although any of these could be true.

The complication of property in these already quite illiquid vehicles, which have estimated combined assets exceeding £350bn, means that the knock-on effects of asset sales from these products, no matter which one, will be great.

The next few months will be interesting to see as the continued fallout from the liquidity crisis continues.


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