Standard Life's With-Profits fund has previously been cited as a classic example of how asset allocation has been driven by governance issues but, as Kira Nickerson reports, its equity weightings have slowly been increasing
The £43bn Standard Life With-Profits fund continues to be light on cash and strong on fixed interest but equity weightings have been on the rise over the past year, according to the group.
Overall the fund is being positioned somewhat defensively in light of increased volatility in both equity and bond markets, manager of the fund, Euan Munro, head of multi-asset investing at Standard Life Investments, says.
The Standard Life fund has seen some rocky times in recent years, having been criticised heavily in the early part of the decade for the stiff exit fees it placed on products linked to the fund following stock market falls. Although one of the last insurers to take the step, in 2002 the then-mutual life office cut its with-profits payouts bonuses, as well as levied high market value reductions (MVRs) for early leavers. Bonuses were cut again the following two years and exit fees moved as high as 25% in some cases.
While Standard Life was not the only insurer experiencing such issues, nor was it alone in cutting maturity values or raising MVRs, it was unfortunately aligned to some degree with problems at Equitable Life. In January 2004, the Independent reported: "The 2.6 million policyholders at Standard Life thought they had nothing to worry about. They had invested in a venerable Edinburgh financial institution, a mutual with nearly 200 years' experience that was morally bound to look after their money with prudence. Like Equitable Life, in fact. So after hearing the news that Standard is raising £750m and is considering a stock market flotation to meet solvency demands set down by the City regulator, policyholders are left shell-shocked, not knowing whether to abandon ship or hang on."
Under the FSA's new capital requirements and regulations concerning with-profits, plus Standard Life's planned demutualisation, its fund was cited often as a classic example of how asset allocation was being driven by governance issues rather than investment opportunities. Like many with-profits funds in the country, the portfolio was moved to a heavy position in bonds, at the expense of equities.
The criticism it now suffers is that it is incapable of returning to a higher equity weighting, limiting the growth opportunities equities hold for policyholders. Yet Standard Life reports it has been increasing its equity weightings, although not dramatically, with a 2.5% rise seen in its equity backing ratio (EBR), the proportion of equities and property backing many of its with-profits policies, in 2006. The firm has six different EBRs, each reflecting the different types of guarantees linked to the fund and as of the end of 2006, these ranged from 27.5% to 71% and were some 2.5% higher last year than previous targets.
The lower the EBR, the lower the anticipated return. The predicted return for 2006 for policyholders in unitised pension plans linked to the fund (with an EBR of 27.5%) is 5.9% and for with-profits annuities the EBR sits at 52.5% with an expected gain of 10.9% for the past year.
Jim Black, actuarial director at Standard Life Assurance, says: "With target EBRs of anything up to 62.5%, or 71% for stakeholder policies, customers are now well-placed to take advantage of any future upside."
As the firm has six different EBRs, it also has five different asset allocation mixes within the fund to meet the various products' targets. Prior to 16 May 2004, there was only one asset allocation for the fund and then up until December 2005, there were two. Since the beginning of last year there has been four, excluding stakeholder, which has the highest EBR of Standard's with-profits products.
For example, unitised life plans, such as pension policies, utilise asset mix number one which, as of 31 March 2007, consisted of 65.6% in fixed interest, 3.1% in cash, 9.6% in property and just 21.7% in equities. This compares to the asset mix for with-profits bonds which features 33.2% in fixed interest, 1.6% in cash deposits, 20% in property and more than double the equity weighting of unitised life plans, at 45.2%.
Today, within the equity portions, the investment team managing the assets is heavily weighted towards the domestic market with 73% in UK stocks followed by a 10% position in European companies. Still the fund has a fair exposure to emerging markets and Asia with 5% in Pacific Basin equities and 6% in emerging markets and non-quoted equities.
Low risk holdings
The fixed interest portion of the fund is predominantly low risk holdings with 83% of that allocation invested in sovereign debt and just 17% in corporate bonds, 97% of which is in investment grade issues.
Munro says: "During 2006, changes to the house view made by the Global Investment Group (GIG) included taking UK equities, a more defensive asset class, to a very heavy position and moving emerging market and Pacific Basin ex Japan equities, riskier asset classes, to light positions. The house view had anticipated the high probability of an economic slowdown, specifically in the US, as well as rising risk aversion and more volatility in equity markets, favouring defensive over higher beta assets.
"This position restrained performance as emerging equity markets performed well in the final months of 2006 and early 2007. Investor risk appetite was high in an environment where there were limited expectations for changes in monetary policy by any of the major central banks."
Still, he points out there were some warning signs on profits as at the corporate level companies appeared willing to sacrifice margin to try to keep market share. Technical analysis of emerging stock markets also suggested caution, he says, adding this stance paid off following the market correction seen in late February, lead by that region.
"Our analysis concluded that this correction was likely to be a normal one during the expansion phase of the business cycle, rather than a major correction caused by a significantly economic disruptive event," he says. "Historically in these corrections, more defensive assets, such as the UK stock market, have performed better than higher beta assets such as some of the emerging markets in the early phases of the correction."
With all the confusion with regards to closed and open with-profits funds, it is worth noting the Standard Life fund remains open to new investments, just not via certain products. Some of this is the company's choice, some it would appear to be market forces. For instance while the fund remains a link for investment bonds, which the life office first introduced in August 2000, only four were sold between July and December of last year. According to the group it no longer sells endowment policies linked to the fund, although existing investments via this route continue to be managed n
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