The great debate: Linked products vs endowments
Both routes have much to offer investors - in the final analysis the individual's particular needs should be the yardstick, writes LEIGH ROBERTS
In the past few years there's been a swing away from investments offered by life assurers to the new investment products born from the unit trust industry. According to estimates, in the last year the life assurance companies have lost over R5-billion to this new industry.
Linked products offer similar investment products to life assurers, for instance retirement annuities and lump sum investments, but the difference is they have a spread of unit trust funds as their underlying investment base.
But while business is booming for the linked industry, there is an ongoing debate as to the preferred route for an investor who has a lump sum to invest. This week, the Northern Transvaal branch of the Institute of Life and Pension Advisers played referee between Llewellyn van Rensburg, of linked products company Momentum Administration Services, and Dave Hudson of Old Mutual.
"Linked products go one step further than traditional investments. They are a new way of doing old things, and give the investor greater flexibility, accessibility, and transparency," says Van Rensburg.
There is flexibility as the investor can choose which unit trust funds his money goes into, and can switch funds at any time.
The accessibility comes in as the investor can withdraw his money at any time without paying an early surrender penalty, as he would under an endowment policy.
The high transparency of linked products is in line with the new age of consumerism, and refers to the disclosure to the investor of the costs payable on the investment.
In contrast, an endowment policy is inflexible and the investor never knows the full costs charged to his investment, says Van Rensburg.
Hudson's riposte: "People criticise endowments for limitations that disappeared 15 years ago. Endowment policies have changed dramatically since then."
He says endowment policy investors do have flexibility in market sectors as they can switch between the investment portfolios offered by the life assurer, for instance, from equities to a stable fund. Unlike a linked product, the investor cannot switch between the trust funds of different management companies, "but switching between funds can be expensive to the investor and generally leads to backing 'last year's winner' which is almost always the wrong option for the investor".
If the investor signs up for a lump sum endowment (the minimum term is five years), but needs the cash before then, the cost of disinvesting is similar to the cost of disinvesting from a linked product.
An advantage an endowment has over a linked product is the tax-free income earned by the investor at the end of the period, which can be especially useful to investors in high tax brackets.
The guarantee given on the capital invested in an endowment policy is a benefit often overlooked by investors, says Hudson. The modern endowment policy offers the investor a high level of exposure to the equity market without putting his capital at risk. In the case of a linked product your investment is at the mercy of the volatile stock market.
A comparison of the performance of the two investments is not an issue, says Hudson, as both products allow the investor access to the same investment markets. On the thorny matter of costs, Hudson says the flexibility offered by linked products comes at a price and it's important that investors are aware of what they are paying. As to which product costs more for a lump sum investment, the speakers naturally have different views.
Hudson says a modern endowment costs less; Van Rensburg counters that the charges are not that different. "But the difference is we show our costs to the investor whereas with an endowment you can't separate the costs."
On the transparency issue, Hudson says the life assurance industry is moving to a key features document which shows the investor the surrender values of the policy in the first few years.
The parties agree there is a place in the market for both types of investment.
"Linked products are for informed investors at the upper end of the market. They are not for the faint-hearted as there is a higher risk, because the decision on where to invest the money is in the investor's hands," says Van Rensburg.
"Comparing the two is rather like comparing a microlight and a Land Rover in terms of different needs. Both products offer the investor different options, and the investor will pay for these options on both sides. It all depends on which of the options are more important to the investor," says Hudson.
But it's a different story for a recurring premium investment. The early surrender penalties on an endowment are far more severe because of the upfront costs.
An independent financial adviser, Johan Marais of JMM Investment Services in Pretoria, gives his advice on the lump sum endowment versus linked product issue. "As a rule our company prefers linked products. There are only three instances when endowments should be considered. Firstly, if a conservative investor wants stable growth, then I recommend an endowment with a smoothed bonus portfolio (this is where annual returns are evenly spread over the term which takes away the risk of market volatility).
"Second, if the investor wants foreign asset exposure; a full foreign asset portfolio is offered only by life assurers and not by unit trust funds (who are limited to a 10% foreign holding). Third, if the investor is not going to take the time to manage, or get a financial advisor to manage, a linked investment."