By advising investors to transfer the £46bn currently held in Peps into other investment vehicles, advisers can help their clients gain higher returns and boost an industry suffering from a lack of fresh cash
Even before the events of 11 September, 2001/02 had not been a good year for Isa sales. The traditional tax year-end rush was marked as much by the disappearance of saturation advertising as the volume of new business.
According to the latest Inland Revenue statistics, from 6 April 1999 to 5 January 2002, £39bn was subscribed to the stocks and shares component of Isas. The Revenue's statistics for Peps are less up to date but the numbers are more impressive: as at April 2001, the total value of Pep investments amounted to £81.09bn, nearly twice as much as in Isas.
Statistics from the Investment Management Association (IMA) show a similar picture: at the end of April 2002, the value of Peps was £46bn, against £25.4bn for Isas.
At a time when volatile markets mean investors are reluctant to commit fresh funds to equity markets, advisers cannot ignore that value sitting in Peps, worth about five or six years of Isa contributions. This is the perfect time to review existing Pep holdings and make the appropriate transfers and/or switches.
Pep money is money that is committed to the markets. Unless a client wants to lose their tax benefits, their Pep funds must be held in equities or bonds.
The alignment of Pep investment rules with those of Isas and the facility to make partial transfers have expanded the options for existing Peps. It is easy to forget that the April 2001 change to permitted investments was only one of a series of reforms that have been made to Peps.
Over the years, many Peps were specifically designed to match the investment limits prevailing at the time rather than meet a particular investment objective. One obvious impact of the investment rules has been a bias towards UK holdings. Even now, according to the IMA April statistics, the UK All Companies and UK Equity Income sector account for nearly 52% of Pep funds against just under 40% of the unit trust/Oeic market as a whole. The distinction between qualifying and non-qualifying funds, which has now disappeared, also drove investors into funds holding at least 50% in UK and/or EU securities.
This was not the only distortion to be found in the Pep market, as there was a flavour-of-the-month syndrome to many Pep investments. The spring 2000 stampede into technology Isas was by no means the first time that the year-end scramble had been dominated by a particular theme or even fund.
As with the tech rush, justification was often based on recent past performance, with the result that investment was made close to the top of the market. Many Peps remain in such ill-fated funds, their investors unaware of the options now open to them.
In some quarters, there is concern that the FSA will take a harsh view of Pep transfers, because they can all too easily look like churning. The greatest risk is thought to be where the end result is to produce a stream of trail commission where before none existed. Many old Peps pre-date the spread of trail commission and there is a natural reluctance among some fund managers to start paying trail now, even if they would offer it for the same fund in an Isa wrapper.
Those who are concerned about the regulatory risk should remember that a transfer is no more than one aspect of the ordinary process of managing a client's portfolio. In the case of Peps, there is arguably more reason to transfer funds than in normal portfolio management. The old Pep rules produced distorted portfolio structures that are no longer required to protect the tax benefits.
The age factor also has to be taken into account. Peps first appeared in January 1987, so many plans have holdings that date back well over five or ten years. Some could now even be 15 years old. It is entirely reasonable to ask whether these remain suited to your client's current investment objectives.
A good example here is that there can be a strong case for moving out of index tracking funds. In current market conditions, tracking the index is much less attractive than it was in the late 1990s, when active managers went through a difficult period. Since the UK market peaked at the end of 1999, the main indices have largely headed south.
For example, between 31 December 1999 and 31 May 2002, the FTSE All-Share Index fell by 23.6% and the FTSE 100 by 26.6%. In 2000, 2001 and so far in 2002, index tracking has meant following the market down, more than chasing it up.
We have officially been in a bear market now for nearly 30 months. That period makes it the longest, if not the deepest, since the mid-1970s. In a low inflation and low growth world, quality active management and proven stockpicking skills come to the fore. Even within a bear market, there are many growth opportunities to be found at the individual stock level.
For example, over that same 29-month period to the end of May 2002, the FTSE 350 Higher Yield Index was up by 8%. Looking at the last 12 months to the end of May 2002, tracker funds had matched the FTSE All-Share's one-year fall of 11.9%, but some single sectors had performed strongly. During that period, food processors had risen 18.9% and tobacco by no less than 55.5%, proving that there is money to be made if you know where to look.
As many investors are now learning to their cost, not all index-tracking Pep funds were originally marketed as index trackers. In fact, some active investment managers are no more than closet index trackers, their portfolios being run against an institutional investment process with few, if any, major bets made away from the index. Because of their investment manager's paranoia over tracking error, many unwitting investors are left paying active management charges for nothing more than a glorified tracker fund.
They have suffered as many index heavyweights have fallen from favour. Surely investors paying 1.5% per annum should at the very least expect their fund manager to try to outperform the index and not just match it.
In the Pep market there is probably more risk that investors will suffer this fate for two reasons:
l Because of their inherent tax advantages Peps have significantly greater persistency than other non-tax wrapped products. Such inertia can be a temptation for managers to resort to index tracking.
l Some groups have Pep-oriented funds that are no longer actively promoted and can exist in an index-tracking backwater without attracting too much unwelcome attention.
There is a further regulatory point, which advisers should consider. The change to the Pep investment rules took effect nearly 15 months ago. The duty of care that advisers owe to their clients means that the impact of the change ought to be have been considered by now.
One final aspect of Peps that should not be forgotten is the subject of single company plans, which until April last year had to hold a single share for each tax year. These Peps account for over 10% of the Pep market and can now be invested in the exactly same way as Isas.
How many of your clients have such plans ' perhaps holding shares from demutualisations or employee profit share and SAYE schemes? Are such holdings really a sensible alternative to collective investment for the majority of investors?
In summary, there are many good reasons why you should be reviewing your clients' Pep portfolios.
The outlook for equities over the next five years is almost certainly a different one to the rampant bull market that marked much of the 1990s. Different types of funds will be better suited to maximise future growth opportunities in this decade.
Pep legislation has evolved and has led to the potential existence of inappropriate portfolios not necessarily aligned to your clients' current investment objectives. Finally, the merry go round that is the UK fund management industry means that the fund manager originally bought by your client is probably now working at another investment house. Now is a good time to review, well before the next Isa season looms over the horizon.
At April 2001, the total value of Pep investments amounted to £46bn against £25.4bn for Isas.
Unless a client wants to lose their tax benefits, their Pep funds must be held in equities or bonds.
There is concern that the FSA will take a harsh view of Pep transfers because they can look like churning.
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