What do advisers think of with-profits?

Some claim they are too inflexible and too costly, and in fact the guarantees are not worth the inflexibility.

Alistair Cunningham, chartered financial planner at Wingate Financial Planning, says: "I'm broadly against investments that I think people buy for behavioural reasons rather than financial planning reasons. As with guarantees, there's a cost to these guarantees.

"They apply in very limited circumstances and those guarantees make them very inflexible."

He continues: "I think most people are at least as well served by having a diversified portfolio that's appropriate for their investment objectives.

"Broadly speaking you are guaranteed to get a known value at retirement, but the problem with that is that the known value is a minimum sum assured, and it's likely you'll get more by sticking it in cash."

With-profits funds were very popular in the 1980s and 1990s, and most insurance companies operated in this sector, as the promises were enticing: guaranteed minimum capital back at the end of the term, and bonuses every year and at the end of the product's life. 

The issue we have with them is that they are rather opaque in their charging structure so are always difficult to compare.Bruce Dodd

With-profits applied smoothing, offering a decent level of return with a certain amount of protection, something that could be argued is perfectly reasonable for many investors.

Paul Fidell, head of business development for investments at Prudential, suggests: "It started to get a bit silly. Some insurers were trying to take market share, and the way you do that was increase bonus rates.

"People started playing silly games with final bonuses and it got too competitive. To support these higher bonus rates, the insurance companies had to be taking more risk with more exposure to equities.

"Equity markets fell [following the bursting of the dotcom bubble] and many funds were left over exposed to the wrong asset class."

Hard to compare

Many funds then moved into bond investments, which paid a lot less, so the final bonuses ended up being smaller, the funds attracted less money, and therefore had less money to invest with, and it became a vicious circle.

Many could not meet the promises they had made to policyholders. Now the FCA asks for a demonstration of ability to pay out to policyholders, and funds have to hold a higher percentage of lower risk assets.

Bruce Dodd, a financial planner at Tilney, does not particularly like them, despite the changes.

He says: "With-profits tend to only be offered by a few providers, although we do come across older plans that have been running for many years. Some of the older funds have a guaranteed annual bonus of, for example, 4 per cent, which as a guaranteed return is highly valuable.

"The issue we have with them is that they are rather opaque in their charging structure so are always difficult to compare. At a fundamental level the underlying fund is still a mixture of bonds, equities, property and cash the same way as any other fund, the difference is in what the provider tells you about the value of your pot."

He explains: "With a conventional managed fund you get to see exactly how it is performing. In a with-profit fund you see what they have allocated to you in bonus that year.

"This smoothing of returns does not reflect an investment that has no downside risk, it simply means that the provider is retaining some of the gains from the good years and used them to provide a positive return in the bad years.

"Essentially they are intended to make us 'feel' better or less exposed to risk even though we still are."

I can't remember the last time we recommended one but I can think of a couple of clients who have with-profits bonds.Nick Bamford

Mr Dodd notes: "The risks in a with-profits fund are that they apply a Market Value Adjuster which cuts the value of the fund in exceptional circumstances or that the element of terminal bonus that you have allocated to you is reduced if the markets fall.

"So, essentially, with-profits funds have not invented a revolutionary way of managing money or getting your money to perform better, they are just a way of making your annual statement look better."

Nick Bamford, director at Surrey-based financial adviser firm Informed Choice, says he would not automatically think of recommending a with-profits fund to a client wanting to invest new money.

He acknowledges: "I can't remember the last time we recommended one but I can think of a couple of clients who have with-profits bonds.

"Both of these people have Prudential with-profits bonds. They have both held them during a very long period of time, taking withdrawals and I find they have a very positive capital position.

"Looking at both of them, they've had a good experience."

He asks: "What are the downsides? It's on client understanding and the transparency of it. But if things do work and you can evidence that they've worked, it's best not to be heavily critical of them. 

"Would I consider with-profits funds? No. That's not to say they're all bad, and they can do some good stuff for some clients."

melanie.tringham@ft.com