In the pension freedoms world, Prudential’s PruFunds range has become a drawdown Goliath, Jack Gilbert writes. It had £32.6 billion of assets under management in September 2017. And it had a share of around 30% of the advised income drawdown market at the end of 2016, according to the Association of British Insurers.
Indeed, its success prompted Aviva to launch its own version of the fund range at the end of 2017. As advisers push ever more client assets into PruFunds, particularly from final salary transfers, we ask whether it really is the silver bullet for the drawdown market.
A smooth ride
The PruFunds range comprises a series of risk-rated funds. ‘Essentially there are two parts to PruFunds,’ said Paul Fidell, Prudential’s head of investment business development. ‘First, there is the underlying investment engine, which is a well-diversified multi-asset fund.
‘So, in that respect, it is similar to many other big multi-asset funds. It is diversified across a range of asset classes run with the objective of providing decent levels of returns at relatively low volatility. The difference with PruFunds is the smoothing mechanism that attempts to remove some of the short-term volatility.’
The smoothing mechanism is delivered through an expected growth rate (EGR). Fidell explained this is the expected annualised return from the underlying assets over a period of around 10 years. The EGR, typically around 5% to 6% a year, increases the unit price of the fund on a daily basis.
With the EGR, there is a ‘smoothing corridor’ in which the EGR is checked against the actual value of the assets on a quarterly basis. If the fund value is more than 5% above or below the EGR, there is a unit price adjustment.
‘Let’s say the client sees a value of 100 pence per unit. We are at one of the quarterly dates and the actual value of the assets is 106 pence per unit. That is more than a 5% difference, so we would move the unit price halfway, to 103 pence,’ said Fidell.
These price adjustments have only happened nine or 10 times since PruFunds launched (as shown in the sharp jumps or falls in the unit prices in chart 1, above). This consistency of returns is why investors use the range, Fidell said.
But how would PruFunds do in the event of another market crash, such as that of 2008? Well, chart 1 shows a small dip in value for two versions of the same PruFund immediately after their November 2008 launch.
The difference in the performance of the two versions is down to tax. Both have the same asset allocation but the S2 version is an onshore life fund with tax deducted at source, whereas the Pen Ser A fund is a gross pension version that is not taxed at source.
Fidell accepted that, though PruFunds are designed to protect clients from market volatility, they are not immune from market downturns. ‘It would be naive to suggest PruFunds could defy gravity and, if everything started to fall, it would magically go in the opposite direction. It wouldn’t,’ he said.
‘The key thing is the smoothing mechanism would provide a lagging effect. So it will put the brakes on when the market goes into extreme free fall and, because the smoothing is done on a quarterly basis, you will have a slight lagging effect.’
Equally, if the market enjoyed a dramatic upswing, the fund would not instantly rise as sharply as the market. In fact, chart 1 shows the underperformance of two PruFunds against the Investment Association benchmark in 2009, 2010 and 2013.
According to an investor presentation released in November 2017, Prudential’s funds have seen big inflows from national advice firms and networks (see chart 3, below, which refers to Prudential funds as a whole, not just PruFunds).
Indeed, chart 3 shows this accounted for 81% of gross flows, while chart 2, below, shows the rapid increase in assets under management for PruFunds since 2012.
PruFunds has been ‘very strong in pension transfers…driven by the smoothing and the diversified multi-asset investment solution’, Clare Bousfield, Prudential’s UK insurance chief executive, said in the presentation. ‘The PruFund fits a massive sweet spot in terms of a post-pension freedoms environment,’ she added.
Bousfield suggests the fund range has been used to mitigate risks following transfers from defined benefit (DB) schemes. But, as Prudential acknowledged, funds returns are not guaranteed.
David Penney, director of City of London-based Penney, Ruddy & Winter, said markets have enjoyed several very good years and advisers should not be too reliant on the fund for transfer advice. ‘I do worry people look at it as a cash account, because it pays out such smoothed returns,’ he said.
‘They have been bloody good at predicting what will happen, but everyone has been looking at it with a rising market,’ he added. ‘People might think they are protected, but they are not: it is just a multi-asset fund. You could say it sort of looks like a guarantee, but it definitely is not. It just gives you an indication.’
Henry Tapper, founder of auto-enrolment adviser Pension PlayPen, made a similar point in British Steel members, who moved every client into PruFunds following the transfer.
Stephen Girling (pictured above), managing director of Norwich and Ipswich-based SG Wealth Management, said the reason so many advisers are attracted to PruFunds is because of the smoothing mechanism. But he added this also means some investors end up being rewarded better than others, depending on when they invested.
‘Our concern is, in the past few years, a lot more of that underlying growth has been retained rather than passed on to clients,’ he said. ‘The bonus is meant to reward those who have been in the fund for some time. But the worry is the next generation of investors might see the benefit of the growth on current investors’ money.’
‘Managing volatility in a portfolio that suits your investment risk is better than letting an insurance company’s actuary decide how much will be divvied out at any given time. It is not quite so transparent or easy to manage.’
How IFAs use PruFunds
‘We don’t use it as part of our default offering, but we would use it for diversification or where there is lower [client risk],’ said Penney. ‘It works quite well if you have a Sipp or drawdown, because you have less sequence risk, as it is basically a straight line.’
John Sutcliffe, director of Sunderland-based WJR Financial Solutions, uses PruFunds to bolster up a portfolio at the lower end of a client’s risk appetite and also for decumulation. ‘It provides a nice, not too volatile, place to take money from as it removes the daily volatility drag,’ he said.
‘If you have to take money out of a fund and it has been dropping, you have to cancel loads of units and it has to work harder to come back,’ he added. ‘But if you have one that is, in the main, quite steady, you tend to get a pretty decent end return. We try to use it to mitigate against volatility drag.’
Sutcliffe blends PruFunds with other multi-asset funds, including Aviva’s. This helps him ‘get the best ideas from all of them’.
How with-profits have changed
By Christine Dawson and Shunil Roy-Chaudhuri
Life insurance companies, prior to the bull market of the 1990s, tried to secure new business by producing top-of-table bonuses. This led to excessive but guaranteed bonus rates, most notably from Equitable Life.
Eamonn Flanagan, insurance analyst at Shore Capital, said: ‘Companies were declaring unsustainable bonuses that ate into surpluses in with-profits funds. Providers had big with-profits liabilities regarding previously declared bonuses. Because the surplus had reduced, there was an inability to sell new business as the element of security had now gone.’
Loss of trust
In the 1990s, there were strong stock markets but poor with-profits bonuses. This reflected the adoption of more conservative investment strategies by life insurers to protect backbooks of guaranteed bonuses.
Flanagan added: ‘This led to a credibility issue between investment market performance and bonus declarations. On top of that, once people queried bonuses, they wanted to know how charges were calculated. But it was very hard to find an explicit charge in with-profits returns.’
Moreover, Solvency II requirements were introduced in January 2016 for insurers in the EU. These meant companies with weak balance sheets had to close with-profits funds to new investors.
But Equitable Life is the main reason many lost trust in with-profits funds. It has taken many years for their reputation to recover.
Equitable Life collapse
The Equitable Life Assurance Society was a huge life insurance company and provider of with-profits annuity schemes. Poor fund management, in particular under-reserving (not setting aside enough capital against its liabilities), led to its near-collapse and millions of short-changed clients.
Equitable Life closed to new business in December 2000. Increasing life expectancy and falling interest rates had contributed to its increased liabilities. As the company could not meet the annuity rates it had promised, it cut rates to existing policyholders by up to 50%.
A compensation scheme was established in 2010 to pay out around one million policyholders. This followed an inquiry, set up in 2001 and led by Lord Penrose, after the Department of Trade and Industry and the then Financial Services Authority failed to challenge Equitable Life on under-reserving.
Penrose stated in 2004: ‘Principally, the Society was author of its own misfortunes. Regulatory system failures were secondary factors.’
In March 2017, Conservative MP Bob Blackman criticised how the compensation had been managed. ‘[Then chancellor, George Osborne,] accepted at the Dispatch Box the total sum to be paid in compensation should be £4.1 billion, but 895,000 people have received only 22% of their losses.’
Policyholders first took legal action against Equitable Life in 1999. Campaigners continue to fight for justice.
Before its collapse the company’s marketing had emphasised it did not pay commission to intermediaries. But it was not transparent about how much it paid its direct sales force.
Today, however, Prudential, Scottish Widows and LV= have with-profits funds that Flanagan confidently describes as ‘big, strong, robust and stable’. He added that M&G Investments, which manages Prudential’s investments, has put in investment performance he equally confidently describes as ‘terrific’.
‘You’ve got greater clarity of the link between market performance and with-profits bonuses and there’s greater transparency over charges,’ said Flanagan. ‘The Prudential with-profits fund is big enough now that they don’t have to have an investment strategy to protect investments of the past.’