Spurious Growth

In my recent Pastoral Care article, I ranted about the mis-match between likely growth rates on a Prudential with-profits pension and the growth rates quoted on illustrations. Now we have had some action from our common regulator, the Financial Services Authority, because Prudential very kindly sent me an e-mail headed “Changes To Prudential’s Approach To Lower Growth Rate Illustrations”. The attachment continues:-

“In April this year we introduced the option to produce Lower Growth Rate Illustrations for a number of our products. Following further guidance from the FSA, we are now changing our process. From 30 August a Lower Growth Rate Illustration will be produced is appropriate, based on the fund selected”.

This is good news but are the future growth projections (which far too many investors take as gospel truth) still realistic? For starters, no equity fund projections have been adjusted downwards and my big beef is the mid-rate interest return on cash funds. In terms of the Prudential pension fund, the reduced expected growth rate on cash is now 4.75%. An investor is most unlikely to be able to earn such an interest return unless the money is locked-in for a long time. The danger here is that the cash return is not what investors think it is – ie interest on a simple bank deposit account but incorporates mystical “Money Market” funds which can have all sorts of different cash-type investments in the portfolio pot. You may remember that not long ago Standard Life had to compensate 97,000 pension investors for losses on its Pension Sterling fund when it emerged that a) the fund had fallen in value and b) there were all sorts of oddities in the portfolio. Another problem is that after deducting, say, a 1% annual management charge, I have seen clients pension cash accounts produce a negative return over the past 12 months. And with Government efforts to curb public sector borrowing, Britain is likely to stay in the economic slow lane for some time - so the chances of interest rate rising in the next 2 years are fairly modest. Add in house prices falling because of a lack of mortgage finance and higher interest rates are probably some way away.

So will other life offices follow the Pru’s move to lower quoted growth rates – a welcome move in itself? There is little sign of anything happening. I have just had information about a client’s paid-up pension with Friends Provident. One policy quotes projected fund values rising at 5%, 7% and 9% a year but the money is in a with-profits fund which is guaranteed a regular bonus rate of 4%. It could be more but it is most unlikely to be more. So, again, quoting much higher growth rates simply bamboozles the average investor. Rather strangely the second policy for non-protected rights only quotes growth rates of 5% and 9% a year and I am waiting to obtain some information on its with-profits bonus rates. They are not going to be anywhere near those projected value figures over the past 5 years and probably for the next 5 years.

The purpose of this rant is to alert readers to the fact that quoting growth rates of up to 9% a year in a low interest rate, fairly low inflation rate environment and with rather flat stockmarket returns is no longer appropriate.