30 January 2015
With-profits finally on the way out
With-profits funds are the epitome of much that is bad in the financial services industry. These are products which, on the surface, look to be the answer to every investor's dream - promising better returns than the bank, but some protection from the risks and uncertainties of the stock market.
The reality, however, has been more of a nightmare than a dream for many of the millions who invested in them. They were most ubiquitous in the 1980s and 1990s, when they were sold by the dozen to millions of homebuyers as endowment plans that were designed to pay off their interest only mortgages. Shortly after the turn of the millennium, it became clear that many of these funds would come nowhere close to delivering what they promised, and banks were forced to pay many hundreds of millions in compensation to the customers they had misled.
This should have been the end of with-profits - and for many companies it was. But a few of the largest insurers limped on, insisting that these were products that were popular with their customers.
Asking the wrong question
As I've written many times before on this blog, asking your customers what they want when it comes to finance is not always a great basis for deciding what to do. It's no surprise that customers said they wanted better returns than the bank with no risk. But instead of being presented with with-profits funds as the answer to their prayers, they should have been told that no such product exists.
The only reason with-profits funds survived into the new millennium was because they paid large commissions to the advisers who sold them. Regardless of all that had passed, a number of independent financial advisers continued to flog these to their clients long after the mortgage endowment scandal had blown up - unable to wean themselves off these generous kick-backs.
With-profits aren't just a poor product because they give false hope. Worse than that in my opinion is that they are expensive, and there's very little clarity around how much the manager is charging, and how bonuses are calculated. They're also incredibly inflexible, and hit investors with hefty charges if they decide to leave the fund at the wrong moment.
The beginning of the end
This week, however, Legal & General - one of the UK's largest insurers - finally announced that it was turning its back on the market, admitting that sales had plummeted since IFAs were banned from taking commission for selling investments a couple of years ago. It is now closing its with-profits fund to new business - and let's hope it will be the first of many.
Sadly, Prudential, Aviva, Royal London and LV have all subsequently stated their commitment to with-profits. It's perhaps all the more depressing that two of these companies - Royal London and LV - are mutuals, who are owned by their customers. I'd have hoped that they might have pulled out long ago.
And of course we shouldn't forget that only a few months ago, Axa's Sunlife Direct brand launched a new with-profits proposition, in partnership with yet another mutual, Scottish Friendly.
I can't imagine that many new, young IFAs would consider selling with-profits funds. I'd wager that it is only a small number of older practitioners who continue to push these on their customers - and these will eventually fade away.
In the meantime, I still have a grave concern about what happens to the many people whose money is left in the funds that are closed to new business. Many of these customers get a poor deal, as their funds no longer have the same incentives to deliver superior investment returns - and the charges for them selling out are prohibitive.
It's an issue that the regulator is looking at - and let's hope its work concludes with some strong action that will deliver a good deal for those trapped in old with-profits funds, and will make it clear to existing players that they need to be more transparent and offer a better deal to customers.