Do second-hand funds gather dust?

Traded endowment policies (Teps) have historically been marketed and regarded as low-risk investments. But questions are being asked about the attractiveness of the £160m- to £202.2m-a-year Tep fund market after liquidity problems, falling bonus rates and the general disenchantment surrounding with-profits policies.

Traded endowment policies (Teps) have historically been marketed and regarded as low-risk investments. But questions are being asked about the attractiveness of the £160m- to £202.2m-a-year Tep fund market after liquidity problems, falling bonus rates and the general disenchantment surrounding with-profits policies.

The second-hand market in with-profits endowment policies is growing. Policyholders who want to cash them in are realising they will get a better price if they sell on the Tep market than if they surrender them to the issuer. Investors get a mid-term policy with attaching bonuses, which may give a good return with limited risk, and there is the added advantage that the fund manager makes the decisions.

But there have been problems. Last December, a prominent Tep fund, the £100m Secured Profits, suspended redemptions and subscriptions after investors withdrew 25 per cent of its assets over six months. Surrenda-Link, which manages the fund, proposes splitting it into the Restructured Secured Profits Fund and the Liquidation Pool. Shareholders have until Friday to inform the company which of the two they want their investment to go into.

The restructured fund will not allow redemptions for two years; thereafter, they will be limited to 20 per cent a year per investor for three years. Roger Lawrence, director of Shepherds (Financial), admits there are liquidity issues with Tep funds, although he is keen to stress that even equity funds have limits on the amount they can liquidate at one time.

Mr Lawrence says: "If a Tep fund has £50m, of which 25 per cent is invested in Standard Life policies, for example, it is very difficult to switch suddenly into other policies."

But this is not the only challenge facing Tep fund providers seeking to persuade people to invest in them. Alan Steel, managing director of Alan Steel Asset Management, is wary of Tep funds because their underlying investments are with-profits policies.

"I am unhappy about this investment because these funds cannot diversify and it is not an area that will provide much growth," he says. He adds that although investors in Tep funds benefited from the "crazy reversionary bonuses of 25 years ago, when life companies were trying to outbid each other, bonuses have since been falling... If they were invented today, with-profits policies would not get past the drawing board."

Brian Goldstein, managing director of Policy Portfolio, says that many of the problems encountered by Tep funds are caused by the way the fund is set up. He advises investors to look for funds which reduce volatility through high entrance fees, to discourage redemptions, and the imposition of penalties for taking your money out.

However, such measures are dismissed by Tep fund managers. Paul Sands, chief executive of Surrenda-Link, says: "People who invest in these funds need to be told they are relatively illiquid. They are low risk and provide steady returns, and therefore an investor should stay in them for a minimum of five years."

Tep fund managers stress these products are intended as an alternative to keeping money in bank accounts. While bonus rates may have fallen, so too have interest rates and interest earned on bank accounts.

Investors could consider holding Teps in personal portfolios rather than investing in funds. Such a portfolio will allow you to view the surrender values of individual policies, buy different policies and have greater control and flexibility over your investment.

But the trouble with this approach, says one Tep fund manager, is that to gain sufficient diversification in a portfolio at least 10 policies are required. "With a minimum investment of £10,000 in each policy," he says, "an investor needs at least £100,000 for a portfolio."

* Simon Hildrey is editor of 'International Financial Adviser'