IFAs reveal how they invest DB transfer money

As Selectapension research reveals PruFunds dominated a most-selected funds list, three advisers tell Jack Gilbert their investment approach for DB transfer clients

Managing transfer money 

Although defined benefit (DB) transfer values have been at pulse-racing levels, IFAs have a huge task investing them to ensure they are not eaten away by inflation and match the DB benefits. To do this, most advisers are looking towards high-equity exposed funds and many are leaning on active managers.

The success or failure of the pension freedoms will likely depend on how advisers’ strategies cope with market ups and downs, and how ongoing management responds to market changes.

Data provided to New Model Adviser® by Selectapension looked at the most-selected funds for transfer value analysis (TVAS) reports for DB transfers since April 2015, when the pension freedoms came into effect (see table on next slide). Although the data does not show how many of the transfers went ahead, it gives a good indication of the funds that are most common in portfolios following a DB transfer.

What it showed was IFAs are looking to a real mix of funds, with some leaning towards funds that try to offer some protection such as absolute return or smooth-managed funds. Meanwhile, a minority on the list (three out of 20) were passive, showing some advisers are using these index options as part of their DB transfer portfolios.

We look at how three advisers approach the portfolios of DB transfer clients.

Managing transfer money 

Although defined benefit (DB) transfer values have been at pulse-racing levels, IFAs have a huge task investing them to ensure they are not eaten away by inflation and match the DB benefits. To do this, most advisers are looking towards high-equity exposed funds and many are leaning on active managers.

The success or failure of the pension freedoms will likely depend on how advisers’ strategies cope with market ups and downs, and how ongoing management responds to market changes.

Data provided to New Model Adviser® by Selectapension looked at the most-selected funds for transfer value analysis (TVAS) reports for DB transfers since April 2015, when the pension freedoms came into effect (see table on next slide). Although the data does not show how many of the transfers went ahead, it gives a good indication of the funds that are most common in portfolios following a DB transfer.

What it showed was IFAs are looking to a real mix of funds, with some leaning towards funds that try to offer some protection such as absolute return or smooth-managed funds. Meanwhile, a minority on the list (three out of 20) were passive, showing some advisers are using these index options as part of their DB transfer portfolios.

We look at how three advisers approach the portfolios of DB transfer clients.

Paul Stocks, Dobson & Hodge

The most popular fund range among IFAs according to the data was PruFunds, with three of the funds selected 13,560 times in total, making up a quarter of the top-20 most recommended funds since the pension freedoms.

It is one of the sector’s worst-kept secrets that PruFunds, which has over £40 billion of assets, is extremely popular for advisers carrying out DB transfers. The range seeks the objective of providing ‘decent levels of returns at relatively low volatility’, Paul Fidell, Prudential’s head of investment business development, has said previously.

One adviser who uses PruFunds as part of his investment approach for DB transfer clients is Paul Stocks (pictured), director of Doncaster-based Dobson & Hodge.

Stocks said he would put around 75% of the client’s portfolios in a range of funds – often using multi-asset including Vanguard’s LifeStrategy – with the rest in Prudential’s Trustee Investment Plan (TIP).

Pru’s TIP, which holds underlying with-profits and PruFunds, places a cap of 7.5% on annual withdrawals in return for certain guarantees. This includes no market value reductions on regular withdrawals.

Stocks said he uses this PruFund option because it provides an element of predictability around clients’ income. Pru’s TIP also allows for withdrawals at periods of greater market volatility without going into ‘negative territory’, because it provides an element of secured income and avoids the dangers of selling units in market downturns, Stocks said.

Clients taking DB transfers should in theory have higher risk profiles, as they need to recreate the benefits of final salary schemes through their investments. However, Stocks still uses some lower-risk investment solutions in the portfolio, like Pru’s TIP, to provide a ‘plan B’ or a hedge if markets collapse.

He also said clients’ risk profiles and the critical yield are not the only things that matter for DB transfers. Other elements such as flexibility and early retirement are also important factors in the pension freedoms world.

‘One part of the Sipp is income focused, i.e. the with-profits part, and then the other side [the fund portfolio] gives the flexibility and market-correlated growth,’ he said.

Eugen Neagu, Montfort International

While some firms like to rely on an element of income stability that can be provided by smoothed funds, others look to active managers to provide the required returns following transfers and limit volatility.

Eugen Neagu (pictured), head of financial planning at Montfort International, is one adviser who turns to active funds. These include Fundsmith Equity, managed by Citywire AA-rated Terry Smith, and the Jupiter European fund, managed by A-rated Alexander Darwall – both of which featured in the top 20 most selected.

Fundsmith Equity was the fourth most-selected fund for Selectapension TVAS reports since April 2015. It has returned 84.7% over the period, compared with the FTSE World index, which returned 45.5%.

Jupiter European invests in ‘good quality companies’ that have a high barrier to entry, according to Neagu. In theory, this should limit volatility and ‘give clients some chance of outperforming the global indices’.

Neagu said advisers should use funds with high equity allocation for DB transfers ‘if the clients are to have a chance to get similar or higher benefits than the DB scheme.

‘If you transfer from a DB scheme you need to have a higher risk tolerance and capacity. That will result in investing a higher proportion of your funds in equities to have a chance to get similar benefits to the DB pension, otherwise you should have stayed in the scheme,’ he said.

Henry Gaskin, SG Wealth Management

Henry Gaskin (pictured), chief investment officer at Norwich-based SG Wealth Management’s, said the firm does not treat clients who have completed a DB transfer very differently to other pension investors. Instead the firm looks to use different parts of the client’s portfolios for different parts of their retirement.

For example, if a client is close to taking income, the firm will use a cautious strategy for part of the portfolio, but another part will be exposed to more risk for future income.

Gaskin said he also phases the process of buying funds for DB transfer clients so they are not all moved out of cash at the same time.

SG Wealth recommends absolute return funds in its portfolios, but it was one of the many advisers that sold out of Gars in 2016 – a decision Gaskin now feels is justified. According to Selectapension in 2015 Gars was the most-selected fund for TVAS reports (619 times) and was the second-most chosen in 2016 (817 times), however it did not appear in the top 20 for the following two years.

Since Gars’ popularity peaked in 2016 the fund has underperformed significantly, falling 8.1% from April 2015 to January 2019 (see chart below).

Despite Gars’ woes, Gaskin said some absolute return funds have been better at meeting their goals.

‘Despite what they say, Gars would have to have been challenged by its size in terms of executing trades; it must have been more difficult to manage given its success,’ he said. ‘But it has not been alone in being challenged in that [absolute return] space.

Still, ‘there are other funds that look to limit volatility and provide a meaningful return that don’t have the marketing clout of Standard Life behind them, but have a better investment return and output,’ he said.

‘We try to blend a number of those uncorrelated [absolute return] funds together. Because, as long as they are not all doing the same thing at the same time, the overall return by blending them will be better for the client.’

 

Peaks and troughs

Almost every IFA will take a different approach to handling DB transfer portfolios. This is hardly surprising given the huge range of funds in the market. What is noticeable from the data, and speaking to advisers, is how active funds are often the central components of these portfolios – possibly because they are designed to dampen volatility.

Some of these active funds like Fundsmith Equity have exceeded expectations. But there have been some notable examples of poorly performing active funds like Neil Woodford’s Equity Income fund (which was the ninth most selected for transfer money).

The poor performance of individual funds is difficult to foresee. But ensuring clients are properly prepared for these swings is where the financial planner is so important.

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Terry Smith
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