March 2007

Welcome to the 3rd edition of our Financial Connection e-bulletin. This month we have focused on three key areas: The Pros & Cons of Private Equity, Changes to the Basic State Pension, and Treating Customers Fairly.

We hope that you enjoy these e-bulletins. If you have any queries, or would like to discuss any of the issues raised, with one of our consultants, please call us on 0845 788 9933 and quote EM-4489.

Pros & Cons of Private Equity

Following last month's article on investing in commodities, in this second part out of three, examining alternative asset classes, we now consider private equity.

Investing in private equity is high risk and usually involves investment in small unquoted companies. However, at the top end, private equity investments could also involve taking over a large publicly owned company, delisting from the Stock Exchange and then trying to increase the value of the company to make a subsequent profit. Current examples of this include the AA, Somerfield and Birds Eye. The first form of private equity is available to the average investor, the second is usually not.

Private equity investments have become more popular in recent years. The main factors behind this have been attractive income tax advantages for venture capital trust (VCT) investments and strong investment performance; which usually leads to increased investor interest.

Private equity investments also offer strong diversification benefits when held alongside the traditional asset classes of equities, fixed interest and commercial property.

Private equity itself has been described as a major force in destroying complacent, self-satisfied managements and raising corporate productivity. They often take on a large degree of debt and the high interest charges they pay on this may help focus the mind in that regard. There is also thought to be some evidence that private equity creates more jobs than it cuts, due to greater efficiency and stronger economic growth.

From an investment perspective, private equity managers are some of the sharpest around and are explicitly incentivised to bring out the best in them. The venture capital industry claims to have delivered returns well in excess of those from equity markets and would argue that downside losses cannot exceed the amount invested, whereas the upside can be many multiples. So, it is possible to get big eyes when looking at this asset class and it is proving to be of more interest to large pension funds looking to boost returns and diversify holdings. However, there is some question as to the validity of performance in this arena as transparency is far from ideal.

The reality is that this is an asset class with extremely high variability of returns. Some high profile investments have produced stellar performance and these have pushed up average (mean) returns across the industry. However, this can be misleading because the best returns are often produced by funds that are not available to the general public and median returns from private equity will be considerably lower. This means that many investors could end up disappointed. There is quite a price for this risk too. Annual management fees usually range between 1.5% and 2.5% and will include performance fees, typically of 20% of the leveraged profits, as well as transaction and monitoring fees.

Private equity funds are often illiquid. This illiquidity means that investors may be faced with long periods before they can access their funds or pay a heavy price if they want access to them at short notice.

The issue of liquidity is likely to be one that is felt by many VCT investors from April 2007. The Government offered 40% initial income tax relief on VCT investments from April 2004 and this resulted in many investors jumping in when these investments were not likely to be the most suitable for them. At the time, the income tax benefit was conditional on holding the investments for three years. The three year periods start to come up from April 2007 and many are likely to be disappointed that they will face a high penalty if they wish to get out. Private equity investors should look at an investment period of 10 years or more.

With high risk, high charges and potentially poor liquidity this is not an asset class for the average investor. The pull of attractive tax benefits has undoubtedly lured many into an asset class that is unsuitable for them and it is hoped that, in an environment that has been relatively favourable in recent years, the investments are able to meet their expectations. However, while we do not pretend to be able to predict the future, it has been suggested that now may not be the best time to be invested. There is greater competition in the sector, perhaps leading to lower returns, and there are arguably more risks in the global economy. Interest rates have also been rising which means an increased cost of borrowing for private equity companies.

That said, the potential for long-term performance and the diversification characteristics offered, mean that private equity could be considered, in the right proportions, for wealthier individuals that have a diversified and balanced investment portfolio already in place and are able to gain access to some of the best private equity managers.

Andrew Wilson

Head of Investment

Changes to the Basic State Pension

The Pensions Bill 2007 proposes many changes, two of the most topical are:

1. A rise in the State Pension age and
2. A reduction in the number of qualifying years for national insurance contributions in order to receive a full basic state pension.

Increase in the State Pension Age

The proposed changes are:

Anyone born on or before 5^th April 1959 will retain a state pension age of 65. For people born after 5^th April 1959, the State Pension Age rises in stages.

In a nutshell, the state pension age will be increased from 65 to 66 between 2024 and 2026, from 66 to 67 between 2034 and 2036 and from 67 to 68 between 2044 and 2046. People born after 5^th April 1978 will get their state pension on their 68^th birthday.

While these changes are to be implemented over quite a long period, it would be no surprise if there were further changes to the state pension in the years ahead. We have an increasing problem with an ageing population and not enough funding, and so further increases in the State Pension Age or increased means testing of benefits should not be ruled out.

National Insurance Contributions (NICs) and the Basic State Pension

Currently, in order to qualify for the maximum basic state pension, an individual must have qualifying years of NICs for approximately 90% of their working lifetime. This means 39 qualifying years out of a working lifetime of 44 years for males and 35 qualifying years out of 39 for females.

This qualifying period is set to reduce to 30 years worth of NIC for both males and females, although it is not yet clear when this change will take place, or how it is going to be implemented.

Many people have paid additional voluntary NICs in order to fill in past gaps in their national insurance contribution record, and thus qualify for a higher basic state pension than they otherwise would.

The proposed shorter qualifying period mean that many will have paid these additional contributions needlessly.  Due to public pressure, the Government has announced that anyone who has made additional voluntary NICs after 25^th May 2006, but would have chosen not to had they been aware of the Government's intention to reduce the number of qualifying years, may be entitled to a refund. This does not, however, help those who find they have made unnecessary contributions before that date.

Charlotte Clarke

Pensions Specialist

Time to Treat Customers Fairly?

The Financial Services Authority (FSA) has concerns about how consumers are treated by financial services companies. These concerns are not without foundation because, on the whole, we believe the financial services industry generally, and the IFA industry specifically, provides a poor service.

As part of their efforts to improve the consumer experience, the Financial Services Authority (FSA), the industry's regulatory body, has launched the Treating Customers Fairly (TCF) initiative. TCF will be central to the FSA retail regulatory agenda, as well as being a key part of their move to a more principles-based approach to regulation.

This essentially means that the FSA will set general objectives and then allow discretion over how financial services companies meet these objectives, rather than applying hard and fast rules.

With Treating Customers Fairly, the FSA want to see an improvement in the behaviour of financial services companies in order to deliver improved outcomes for consumers.

The TCF initiative aims to deliver six such outcomes:

1. Consumers can be confident that they are dealing with firms where the fair treatment of customers is central to the corporate culture.
2. Products and services marketed and sold in the retail market are designed to meet the needs of identified consumer groups and are targeted accordingly.
3. Consumers are provided with clear information and are kept appropriately informed before, during and after the point of sale.
4. Where consumers receive advice, the advice is suitable and takes account of their circumstances.
5. Consumers are provided with products that perform as firms have led them to expect, and the associated service is both of an acceptable standard and as they have been led to expect.
6. Consumers do not face unreasonable post-sale barriers imposed by firms to change product, switch provider, submit a claim or make a complaint.

We welcome initiatives that are designed to improve the standards of the industry. However, we do have reservations over whether principles-based regulation can be effective in an industry that has often proven itself to be unprincipled in the past.

It is a sad indictment on financial advisers that the FSA feel the need to introduce a regime called Treating Customers Fairly, and that many advisers will require wholesale changes in order to comply with these requirements. It provides a clear indication of how many customers have been treated in the past.

Treating Customers Fairly should be embraced by all financial advisers. However, there are certain practises that make treating customers fairly extremely difficult:

Commission-based financial advisers get paid a different amount of money depending on the course of action they recommend. They get paid a different amount depending on the type of product they suggest and the product provider they choose. Even advisers that rely on renewal, or trail commissions, still need to persuade a client to buy a commission-generating product in order to get paid.

The qualification hurdles to become a financial adviser are astonishingly low. The relevant examinations can be passed after relatively little study and no practical experience.

Financial advisers rely heavily on inducements from product providers. Many larger 'independent' financial advisory companies are now partly or wholly owned by product providers. Product providers also provide financial support to advisers for marketing activities, annual conferences and even Christmas parties.

We do congratulate the FSA for the work they are doing, though feel that decisive and radical action needs to be taken before we can truly say that customers are being treated fairly.

Patrick Connolly

PR & Marketing Manager