Client Newsletter - June 2011

Sophisticated Investments

Under new rules which will come into operation on 1 January 2013, independent financial advisers will be required to be able to advise where appropriate on sophisticated investments, including some which are based off-shore and may not regulated by the Financial Services Authority or be covered either by the Financial Ombudsman Service or by the Financial Services Compensation Scheme.

Such investments may be able to access opportunities not available through mainstream on-shore funds, but clearly they are also likely to pose a higher risk, and the FSA has laid down rules which are designed to ensure that they are only recommended to clients who understand these risks.

The main type of funds involved are UCIS (Unregulated Collective Investment Schemes), and the fact that they are not FSA-regulated may mean that they are highly geared with borrowed money; that they are less easily realised; and that the underlying investments may be more speculative. They may also have higher charges.

You may find UCIS with names such as Romanian Growth Fund, Poland City Living Geared Growth Fund, Fine Wine, Flamingo Lake, and Student Accommodation Fund.

Also in the riskier category are certain Exchange Traded Funds (ETFs). Many investors use ETFs as an alternative to index-tracking funds, and they have the advantage of being able to track a much wider range of indices and being able to be bought and sold instantaneously.

However, some ETFs do not own the assets to which they appear to be linked, but instead buy and sell complex financial instruments or ‘swaps’, of the sort which contributed to the global financial crisis. In some cases, the return of funds to investors may depend on the financial stability of the banks which provide the guarantees.

Investors who are minded to consider investments of this sort will be able to rely on their independent financial adviser to sort the wheat from the chaff on their behalf.

Maximising Annuity Income

When it comes to providing pension income, annuities have the unique advantage of being able to provide a guaranteed income for life. It is for this reason that even the wealthier investor is likely to want to spend at least part of their pension pot on buying one or more annuities.

However, annuity rates are relatively unattractive by historical standards and they are likely to become even less attractive as a result of increasing lifespans and the recent European ruling which prevents annuity providers from offering rates which reflect the fact that women live longer than men.

What few people appreciate is that 60% of annuity buyers could get better rates by purchasing an “enhanced” or “impaired life” annuity, the terms of which reflect other factors affecting longevity.

There is a large number of such factors, and although their impact individually may be small, collectively they can be significant.

So-called “qualifying conditions include smoking, obesity, asthma. cancers, heart conditions, diabetes, depression, alcohol intake, stroke, liver conditions, dementia, high blood pressure, emphysema, and high cholesterol; and some occupations and postcodes are associated with  shorter lifespans.

In a recent case study, a 65 year-old with a pension fund of £50,000 was quoted a top rate of £3,121 p.a. for a pension annuity, but when account was taken of her 18 stone weight, the available annuity income rose by 6% to £3,315; then her postcode and the fact that she had worked in a factory was worth a further 7% uplift to £3,527 and finally her alcohol intake of over 36 units per week (= half a bottle of wine per day) justified a further 12% uplift to produce a total income of £3,905 p.a.: a total increase of 25%!

Index-Linked Annuities

With inflation running at high levels, it is unsurprising that investors should be seeking to protect the value of their savings, and pensioners are particularly vulnerable. Hence the popularity of the new National Savings 5-year Index-Linked certificates.

It might similarly appear to be a wise precaution to buy an index-linked annuity. However, there are a couple of reasons to think twice.

First, most index-linking is based on the Retail Prices Index (RPI), which takes no account of the fact that retired people spend a greater proportion of their household budgets than the average consumer on food and heating, - items which have suffered particularly sharp price rises.

In addition, the price paid for index-linking is that the immediate level of income provided is less than would be available from a level annuity, and it may take many years before the index-linker catches up. Indeed, it has been calculated that only if inflation were to run at over 4% a year would the total income produced match that available from a level annuity over the average remaining lifetime of a retired person.

The best answer might be to give index-linkers a miss and to split the pension pot between other types of annuity – perhaps a level annuity and an annuity whose income will increase by, say, 3% p.a.. For the larger pension pot, consideration might also be given to an investment-linked annuity, the income from which is linked to share values, though this will of course involve an element of risk.

No responsibility can be accepted for the accuracy of the information in this newsletter and no action should be taken in reliance on it without advice. Please remember that past performance is not necessarily a guide to future returns. The value of units and the income from them may fall, as well as rise. Investors may not get back the amount originally invested.