How to invest in endowments

Holders of with-profits endowment policies have been getting rid of them since the markets fell in 2000 and bonuses were slashed by insurers. However, there is still money to be made from funds that invest in second-hand policies.

Anyone who is interested in investing directly in traded endowment policies (Teps) will now find it harder then it used to be simply because most of the available policies have already been bought by big institutions, many of them in Germany. It is still possible to find some Teps via “market makers” – people who buy and sell endowments, it is easier to get at them through investment trusts whose assets are based on Teps.

You can get out of an endowment policy in two ways. The first is to surrender it to the company that sold it to you, and the other way is to sell it to a market maker in the hope that you can make more money.

Teps can make attractive investments, particularly for those with a deadline to match with an investment, such as retirement or paying school fees. Tep investment trusts have a specific end date so it should be easy to match dates. Also, in a trust, you do not have to buy a Tep directly – usually costing thousands of pounds - so you can limit the amount you are investing.

It is said that as much as £500m will be invested this year by investment houses buying up policies for these trusts. Investment into a trust avoids the problems of selecting a single company’s policy; a trust has an investment into about 20 life companies, with a good mix.

At present there are only four funds in the UK with investments in Teps, and performance varies considerably. Two of the four are run by Allianz Global Investors. The Allianz Dresdner Endowment 2010 fund has seen a return of 17% in the last year. In second place the Barclays Global Investors Endowment Fund II has seen a rise of 11% in the same time. The Allianz 2010 fund has performed best over three years and five years for lump-sum investments. If, however, you had invested £100 a month over five years, you would have been better off in the Barclays fund.

As the name of the 2010 fund suggests, it matures in that year, and the other Allianz fund matures in 2009. Both have investments in Teps from some of the biggest of UK’s insurance companies: Standard Life, Legal & General, Aviva, Scottish Widows, Friends Provident and Prudential. These companies have a strong background and a good with-profits performance record.

The trouble with endowment policies is that when stock markets fell between 2000 and 2003, a lot of insurance fund managers switched investments from stocks and shares to bonds for safety, and bonus payments were pared to the bone. Although bonds might be a safe bet when stock markets are on the way down, failure to reinvest in shares when they were low has missed a significant opportunity for investors and the performance of with-profits funds has remained depressed ever since.

Anyone looking to invest in Tep policies, either directly or via a trust fund, should understand the profits being delivered from the funds. As ever, there is no guarantee that good previous performance will mean good future returns. Your adviser should be able to do a bit of research to see how the firm providing the endowment is investing the fund. Companies like Prudential and Liverpool Victoria are recommended for Teps investments as they have a higher proportion of their underlying with-profits funds in equities.

The benefit of an investment trust is that the risk is reduced as your investment is spread across a number of funds, so if one has a downturn in performance, hopefully your investment is bolstered by good performance in another fund. A direct investment could leave exposed to the wayward performance of a single fund. Direct investment can also have tax implications. While most policies are taxed at basic rate throughout, there is no higher rate tax to pay on maturity, but they are subject to capital gains tax (CGT) on any gains made. Investment in a Tep trust through an ISA would make it immune to income tax and CGT.

Endowment polices have high charges up front, and this has put investors off. The beauty of a Tep is that someone else has already paid those fees at the start of the policy.

Another point about direct Tep investment is that you have to keep the specific premium payments up to maintain the investment. Part of an endowment policy is life insurance, and when a Tep is sold on the insurance still covers the person who originally took out the policy. However, it seems that any payment made by the policy on that person’s death goes into the Tep. That may not fit comfortably with everyone.

The advice is to look for a Tep investment over three to five years – the back end of a policy.