More relaxed Pep rules mean investors can now easily diversify their portfolios in order to protect themselves from volatile stock markets, says Sandra Lymburn
Current stock market volatility and the Chancellor's relaxation of the Pep rules from April this year makes this a good time for clients to take stock of their Pep portfolios.
The new rules mean that the millions of investors with general Peps can now diversify their UK and European-biased portfolios into global holdings.
The three million plus holders of single company Peps can also now consider transferring their £7bn of subscriptions into General Peps.
Many may wish to consider diversifying their portfolios in order to protect their investments from the worst effects of a volatile stock market.
Single company Peps were introduced in January 1992. Initially, they provided a tax-free wrapper for employees with shares from their own employer's share save scheme.
Later on, they became vehicles for the billions of pounds of new shares entering the UK market following the rash of privatisations and demutualisations in the 1990s. BT is probably still the most common share held within a single company Pep.
The number of single company Peps almost trebled in the 1997-1998 tax year, when Alliance & Leicester, Halifax, Woolwich and Northern Rock all demutalised.
It was very convenient for clients of these former building societies to shelter their new, free shareholdings inside a Pep wrapper without suffering Capital Gains Tax on the transfer.
Many of them will no doubt still hold these single company Peps. But few are likely to have considered whether these holdings suit their needs and match their attitude to risk.
The average building society investor is unlikely to have built up a large investment portfolio of real assets and is probably risk averse. So is it prudent for such clients to have exposure to a single stock?
True, the companies that demutalised tended to be large, solid organisations. But this does not necessarily equate to a steady stock market ride: consider how Marks & Spencer's value fell well before the recent upheaval in global stock markets.
Investing in one stock market without any balancing investments overseas can be risky. Research conducted by Fidelity shows that moving from a 100% UK equity portfolio to a 50% international portfolio reduces volatility by 12.5% (see table one).
Risk and returns
Investors concentrating solely on UK equities cannot benefit from some of the world's strongest performing companies based in the US, Europe and Japan.
Investing in a single company or single country can bring big rewards, but this strategy also carries the largest risk.
Table two shows how a diversified portfolio can reduce volatility.
The highest risk comes from investing in funds in a single country ' some offer a very good return while another produces the lowest of the funds analysed. Choosing a regional equity fund reduces volatility and holding a global equity portfolio reduces volatility further ' and produces a return somewhere between the best and worst performing regional funds, according to Fidelity.
Safety in numbers
The great opportunity for single company Pep investors is to transfer into a general Pep that offers them access to a collective investment with a range of underlying shares or bonds. This equates to safety in numbers in effect.
Clients who have an appetite for some volatility, could, through a general Pep, invest in single sectors such as health, media, finance or technology ' but with a portfolio rather than a single shareholding.
What should clients be looking for? Anyone reviewing their portfolio and choosing a general Pep will probably want a plan that offers flexibility.
The Sterling Pep Transfer Plan, for example, enables any number of individual Peps to be transferred into a single comprehensive plan offering a choice of 59 funds provided by 17 leading fund managers within one sterling 'wrapper'.
This gives investors the opportunity to review existing Pep performance and reinvest their assets across a wider range of funds.
Administration is also simplified ' instead of getting a myriad of statements from different companies, investors keep up to date with plan performance through a comprehensive twice-yearly statement summarising every transaction.
Other benefits clients may seek from a general Pep include:
The ability to switch down the risk scale if and when they wish
The opportunity to take regular withdrawals to supplement income if and when they need it
Some form of protection against loss on death.
While reviewing their single company Pep holdings, clients should also consider whether Peps taken out in the early years continue to meet their overall investment needs.
After all, priorities and objectives may change over time. Good independent advice can help clients re-assess their portfolios and achieve a balance designed to meet their investment aims and match their risk profiles.
Single company Pep investors can now diversify into a general Pep.
General Pep holders can also diversify their UK and Europe-based portfolios into global holdings.
Diversification can protect investment against market volatility.
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