Last month’s article, on whether there is still a place for endowments, drew a range of responses. Given some of the strong opinions expressed, it is worth considering how IFAs can ensure that, if they do use endowments, that they only do so in their clients’ best interests.
1. Changing investor behaviour
It may not be politically correct to say so, but a real challenge for product providers and financial advisers, alike, is protecting investors from themselves. People withdrawing their savings at the wrong times, and for the wrong reasons, is a major cause of poor long term returns.
The most recent Old Mutual Savings and Investment Monitor shows that saving as a percentage of GDP in South Africa has dropped from over 30% in the mid-1970s to around 15% today. Clearly there is a need to find ways to encourage people to invest, and to stay invested, and endowments appear to be more effective in keeping people from accessing their savings.
An interesting example is the Cannon Super Dogs portfolio, which has performed strikingly well for a deep value fund over the last few years. It is currently only available as an endowment because the fund managers want both to prevent investors from withdrawing at the wrong times and allow themselves to invest in stocks that have limited liquidity. The results speak for themselves.
In situations where it is necessary to modify a client’s behaviour through forced discipline, endowments come into their own. And, with the likelihood that old endowment structures will be phased out in favour of ‘sinking funds’ in the near future, it is possible that this may be the only reason to use these products at all before long.
There can be no argument that the commission that brokers can earn on endowments encourage many of them to sell products that were patently inappropriate. This risk still exists.
One correspondent noted: “In my opinion, and given the sophistication of the many and varied investment products/vehicles available in the open market, there exists no justification for upfront commissions of any nature.”
The argument is well made that IFAs serve their clients best when they avoid taking upfront payments. That way they assure both themselves and their clients that there is no conflict of interest and that they are genuinely recommending a product on the basis of its suitability.
However, it is important that all parties understand that there is a potentially unintended consequence. As-and-when payments for the duration of an endowment contract may end up being higher than upfront commission.
The IFA’s responsibility is to make sure that this is explained to the client – both in terms of what the costs will be and why it is important to structure them in a specific way. This both promotes a healthy relationship, and ultimately adds value to the IFA’s business.
The tax treatment of endowments will almost certainly change to bring them in line with unit trusts, but for now they still offer a unique structure. Their tax benefits are, however, really only present for high income earners.
Most people would pay less tax in a standard unit trust or LISP, and any IFA who recommend endowments on the basis of their tax efficiency should conduct a thorough analysis to check that there is genuinely a benefit to the client.
If necessary, this analysis can even be outsourced to a third party tax specialist to ensure that it is completely impartial. That way both the client and the adviser can be satisfied that they are making an appropriate choice.
Readers who wish to comment on this are welcome to email Paul Kruger.