With-profits face fire as returns fall

Investors are being advised to transfer out of their with-profits pension funds, as high fees and low equity exposure take their toll on returns.

Some with-profits pension funds are paying out less than they did a year ago in spite of strong stock market returns, according to a survey by money Management magazine to be published next month.

Anyone who has made regular monthly savings into a with-profits fund for the past 15 years will have seen average annual growth of just 3.4 per cent – lower than on 15-year policies a year ago.

While five, 10 and 20-year policies showed slightly higher average growth as of January 1 2011 compared with 12 months ago, their average annual growth is still nearly half that of an average fund tracking the stock market.

Many with-profits funds now have very low exposure to equities, which stunts their growth over the long term.

Providers with higher exposure to equities, such as Prudential, produced stronger performance. Prudential’s with-profits fund was among the best performers over all time periods studied, with annual growth of 6.2 per cent over 20 years for those who made regular savings. This was in spite of the fact that Prudential’s charges for a pension plan opened today are among the highest.

Others performed barely better than cash over the long term. The worst offenders over 20 years – including Scottish Widows and Pearl Assurance – had annual growth rates of less than 4 per cent.

High fees can have a major impact on performance over time. Fund charges over historical periods are difficult to calculate as providers change their fees over the long term. So money Management uses the current fees charged each year and works out the theoretical impact over a period of time, then compares it with how the fund would have grown if no fees had been charged.

For example, over 25 years, someone who paid an initial 10,000 into a fund growing at 7 per cent a year would have 54,274 at the end of that period if no charges had been levied. If they had been in a standard low-charging stakeholder pension, with annual charges of 1 per cent, they would have 42,215 – a 22 per cent hit. But with HSBC Life, they would have just 32,172 – losing 41 per cent in charges.

Prudential, one of the strongest performers in the survey, also has some of the highest fees on pension plans taken out today: 28 per cent over 25 years using the same assumptions.

High fees have a greater impact over longer time periods. Over five years, HSBC Life would have taken just 5 per cent off in fees on the same basis.

“Forty per cent out of a single premium over 25 years is a heck of a lot of money to take out of your fund,” said Janet Walford, editor of money Management. “If the performance collapses, you’re left with high fees, which can have a devastating effect on the outcome.”

In the past, with-profits funds paid out high commissions to financial advisers who recommended the policies because of their supposed ability to “smooth” returns. But with poor performance increasingly common and many funds now closed to new clients, advisers say that investors should consider taking their money out of with-profits altogether.

Danny Cox, head of financial advice at Hargreaves Lansdown, has not recommended a with-profits fund since 2002. “We think the model is pretty much broken,” he said. “You’re paying high fees for worse performance than cash which is a double whammy of poor investment options.”

He says that with-profits funds work even less well for pensions than other types of investments – the funds are also sold as investment bonds – because of the long time horizon for investors, who are usually advised to put their pension into equities.

However, investors who want to transfer out of their with-profits funds should check the terms of their policies, as they could include guarantees for generous final bonuses – which can be up to 60 per cent of the total amount. Investors close to retirement should therefore consider staying in their funds. A with-profits fund’s exposure to fixed interest will also make more sense for investors close to retirement, who are usually advised not to take too much risk with their pension.