While with-profits funds have lost favour in recent years, Prudential managed to produce a good performance, with total returns of 63.8% over the last five years. Tiffany Hancock reports
With-profits funds have suffered bad press in recent years. The scandal of Equitable Life's near collapse in 2000 has been enough to deter many investors from putting their money in any with-profits fund at all.
But according to Martin Brookes, director of portfolio management at Prudential, it is unfair to tar them all with the same brush.
The Prudential With-Profits fund has produced a pre-tax return of 12.4 % over 2006, maintained annual bonuses at existing levels and increased year-on-year payouts by more than 10% across the majority of policies. Over five years, the total returns have been 63.8%, 13.6% more than the FTSE All Share.
Brookes says: "The fund has been, and remains, financially very strong. We have chosen our assets well and, on the liability side, we have tended to make fairly cautious promises."
Prudential's fund managers have had a strong record in predicting market movements. At the end of the 90s, they scaled down their exposure to equities with the belief that valuations were being stretched. From 2003, they have increased their investment in property and enjoyed the subsequent price rises. Such predictions have been fundamental to the fund's success. "The main driver of how large the return is in a multi-asset fund is the asset allocation decision. How much one chooses to invest in property, bonds and equities will determine what is made over time," says Brookes.
The bulk of the fund is currently in equities, with 37% in the UK and 16.7% internationally. Brookes explains that the high equity backing ratio can be explained by the strong capital position of the fund. It is only because the fund has a strong financial position that it can afford to take on more risk.
Brookes says: "If you don't have that capital to guard against volatility, then you have to run less risky investment strategies and over time the returns are not going to be as good. We are positioned quite differently to a lot of other funds in the with-profits industry which haven't had much financial strength in recent years and have had to de-risk."
Within UK equities, Brookes stresses that there is a high degree of diversification, which allows the fund a degree of flexibility to be aggressive when it sees fit. Roughly 80% is managed with a traditional index-plus approach, with much of the investment in larger cap stocks.
Brookes says that many of the larger caps have underperformed quite significantly in recent years but that the situation is changing. The remainder of the UK equities are run with an absolute return approach, that is, with the fund manager looking for stocks that he thinks are good value, regardless of their weighting on the benchmark. According to Brookes, the UK equity part of the fund has had great success over the past five years.
The international portfolios (which include Asia, South Africa, Canada, Australia, Brazil, Mexico and Argentina) are described by Brookes as being "a lot punchier", holding roughly 40 to 60 stocks in each country rather than the hundreds of the UK portfolio. Within the international portfolio, emerging markets have constituted 30% though that is now being scaled down.
"A couple of years ago we were quite bullish on emerging markets though our enthusiasm has now been tempered a little. That is not to say we are steering clear but more that the big under-evaluation that we saw has been now been eroded as the relative valuations have come in to line with what's available on the bigger markets," says Brookes.
The rest of the fund is spread between fixed income (24.8%), property (15.7%) and alternative assets (2.2% and made up of infrastructure and hedge funds). Brookes says that all are well-diversified.
Of fixed income, he says: "A bond is not a bond any- more. There have been huge amounts of development, granularity and segmentation. M&G has pushed the boat out for us in terms of getting involved in some of those markets at an early stage."
Within property, Brookes points out that investments are not restricted to the UK. "The Pru is now just as likely to be buying retail distribution units in Korea or New York as it is in Leicester or Peterborough," he says.
The asset allocation formula has worked well for the fund but the coming years look set to see some changes. Property exposure will be reduced. "Although it's been one of our best performers over the last 10 years, it has now started to look more expensive," says Brookes. He says alternative assets may double, if the right options come along.
One thing that won't change is the fund's position on UK equities. Brookes says: "They have rallied for four years and I guess it is a bit counter-intuitive that things can continue but the big secret is that corporate profitability has gone through the roof. The price has gone up and the markets have as well but so has corporate profitability, which provides earnings potential over a longer period of time." Brookes believes that equities have been conservatively valued and that nervousness is still embedded in the market, partly owing to concern about the US consumer and also because of the equity downfall in 2000. He admits that a prolonged period of underperformance from equities would impact the fund but says he believes it to be an unlikely scenario.
Despite its equity bias, Brookes describes the fund as a "steady eddie, sleep at night core type of investment". Most of the fund's customers have had a lot of cash on deposit but they now want to take a bit more risk to try and improve the return. Others have got money invested in equities but like the idea of having a cornerstone of their money that is safe.
"Not only can we offer a high degree of diversification but the strong capital position of the fund enables us to sustain a high equity and property backing ratio, which are the assets you hope are going to work quite well for you. The with-profits industry hasn't covered itself in glory in recent years and the Pru has been affected by that. However, our very strong position is that with-profits are not all the same and that ours has been well-managed," says Brookes n
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