Asset allocation shifts could boost with-profits returns

New analysis by Barnett Waddingham (BW) reveals modest shifts in asset allocation could boost expected returns for UK with-profits funds by up to 0.6%, without adding portfolio risk. The annual UK With-Profits Funds report also shows 2023 was a positive year for these funds, achieving an average return of 8.32% despite challenging market conditions.

The UK With-Profits Funds report, published annually by BW, reviews the investment strategies of UK with-profits funds to help UK life insurers determine the appropriateness of their with-profits asset allocations. The analysis covers £239bn worth of assets spread over 76 funds from 24 insurers in the UK, covering funds’ investment returns, asset mixes, sustainability and suggestions for improvement.

In terms of investment returns by asset class, analysis found that the average fund return performed well against each benchmark. For example, UK equity achieved a 7.5% average return against the FTSE All Share Index benchmark of 7.9%, and corporate bonds achieved a 4.2% average return, 0.5% higher than the iBoxx Non-Gilts All Stocks Index benchmark of 3.7%.The only fund which saw negative return was property, with an average return of -1.9% against the benchmark index return of -0.5%.

With regards to asset allocation, fund managers were seen to have increased the allocation of overseas equities while reducing the allocation of UK equities since 2022. Meanwhile, fixed interest holdings have shifted since 2022, with increased corporate bond allocations and decreased allocations of government bonds and cash. The proportion of funds being managed using sustainability targets or criteria also increased in 2023, largely from smaller funds, suggesting they have begun to catch up with larger peers. 

The main risk identified to fund asset allocation was actions of central banks, following a year of frequent interest rate rises. This was closely followed by geopolitical risk as the second most common risk identified, and asset/market value risks. Domestic political risk fell significantly as a risk factor, suggesting market confidence ahead of the new government.

Kim Durniat, Partner and Head of Insurance & Longevity Consulting at Barnett Waddingham, said: “Despite the perceived volatility we saw at surface level in 2023, it’s been an encouraging year for with-profits funds, with nearly all achieving a positive average return. Not only this, but we’re seeing fund managers continuing to adapt to market fluctuations to ensure asset allocations remain fit for purpose, while considering sustainability criteria.

“Looking ahead, it's a delicate balance of maintaining positive performance, while taking appropriate measures to mitigate future risk. And, according to our analysis - there’s room for just that. With small shifts to asset allocation, we estimate with-profits funds could increase expected returns by up to 0.6%, without increasing portfolio volatility. Encouragingly, we’re also seeing positive progress towards better outcomes for with profits policyholders, aligned with Consumer Duty - so can only expect this to continue into 2024. With these factors in mind, now is the time for insurers to review their with-profits strategies and ensure they’re optimising performance for 2024 and beyond."