Widening discounts and the distribution of inherited estates are making teps more attractive
Traded endowment policy investment trusts offer an attractive alternative to investing in zero dividend preference shares, according to David McFadyen, investment fund research analyst at ABN Amro.
Widening discounts have overcompensated for the expectation of future cuts in reversionary and terminal bonus rates, creating undervalued situations, he said.
A further potential for growth, not priced in by the market, is the distribution of inherited estates, something likely to provide a significant uplift to Teps.
McFadyen said: 'Tep trusts present an attractive alternative for zero dividend preference share investors, as they offer defensive investment market exposure while demonstrating consistent long-term returns.'
There are eight trusts investing in Teps, three from BGI, four from Dresdner, as well as Scottish Value Management's Life Offices Opportunities trust. The Dresdner Endowment 2003 trust looks to be particularly good value, said McFadyen.
The trust which is redeemed in October 2003, will benefit from an 11% return even if bonus rates on Teps are cut by 10% this year, he said, adding that many of the cuts the trust will face have already been priced into the valuation of its share.
Simon White, head of investment trusts at Dresdener RCM Global Investors, the biggest player in the market, argues that now is a particularly good time to be in Teps.
He said: 'Negative publicity about with-profits mean prices have been cut and there are attractive discounts for buyers.' He said the fact Teps offer steady capital growth with low volatility means they can be regarded as a safe investment, whereas zero dividend preference shares are not now seen as the safe haven they once were.
Teps with wind-up dates later in the decade also look attractive, said McFadyen. Bonus rate trends tend to lag behind the equity market meaning that longer dated Tep trusts are likely to benefit most when Tep rates pick up again.
Trusts investing in Teps have many advantages over individual investors, said McFadyen, including the ability to negotiate down market-maker margins getting a better deal for investors.
The level of diversification from a trust investing in about 2,000 policies, spread across a number of life companies, brings a reduced level of risk. These benefits come on top of several notable characteristics of Teps themselves. When a trust purchases a Tep, it avoids the costs the original policyholder has already paid. On average, it will have also already participated in at least five years of reversionary bonuses which cannot be taken away. Other benefits of investing in Teps include the likelihood that investors will benefit from future reversionary and terminal bonuses, according to McFadyen.
He said: 'Even a policy that is underperforming the growth rate envisaged at issue can provide a good return to a secondary investor.'
ABN Amro's analysis shows that endowments have provided sound long-term returns while offering a level of guarantee. Importantly, compared with other 'low risk' investments, they have shown strong returns, said McFadyen. The eight Teps trusts on the market have wind-up dates from October 2003 to September 2014. The first trust was sold in 1992, and the market has grown by about £1.25bn in the past three calendar years. Total Teps sales were £500m in 2000, a trend McFadyen believes will continue as increasingly more policyholders realise that selling their policies offers a better deal than surrendering them.
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