UK with-profits funds
Helping insurers understand the drivers of performance
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This report is written for those involved in the management of UK with-profits funds. Our aim is to help UK life insurers determine whether their with-profits asset allocations remain appropriate for them, and whether their asset manager has performed well compared to peers.
The data* used in our report is private information that is not in the public domain. We approached the majority of firms who have with-profits funds in the UK, asking for information on asset allocations and investment returns. Our analysis this year covers £216bn of assets spread over 68 funds from 24 insurers.
Contents
Amit Lad
Principal, Insurance
and Longevity Consulting
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Scott Eason
Partner and Head of Insurance
and Longevity Consulting
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Our experts
Please get in touch with your Barnett Waddingham consultant
if you would like to discuss any of the topics in more detail.
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The information in this report should not be considered sufficient for making decisions, nor should it be used in place of professional advice. This report (and the work carried out to produce it) is subject to and, in our opinion, complies with the Financial Reporting Council’s technical actuarial standard (TAS) 100.
This is the 10th annual investigation we have conducted into the investment strategies of UK with-profits funds.
Analysis as at 31 December 2022.
Numerous events took place during 2022 that have contributed to it being a
challenging year for investment performance. The key events include:
Looking back at 2022
Executive summary
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Increased Covid-19 measures in H1 2022, particularly in China, and the impact on global trade.
The Russian invasion of Ukraine, with rising sanctions and the impact on commodities.
Fiscal and monetary policy implemented to combat rapidly rising inflation.
Announcement of the UK September 2022 growth plan.
All with-profits funds experienced a negative return, with the average return being -11.7%. While this sounds bad in isolation, the wider economic environment should be taken into account, and we note that on average, with-profit funds outperformed our benchmarks for most asset classes.
Investment returns
Most individual funds have a balanced asset mix backing their asset shares, and the average asset mix has remained relatively stable for many years demonstrating a long-term investment view. There has been an average decrease in allocation to corporate bonds and an increase to hold more government bonds.
The change in asset allocations for individual funds has not fully mirrored the expectations that funds provided in our survey last year. We understand in some circumstances that this has been due to holding off significant changes during a volatile year, and that these are likely to be revisited again in 2023.
Asset mixes
The main risk that most funds view as likely to affect asset allocation continues to be geopolitical risk. Compared to previous years, central bank actions and domestic political risk are much higher on funds’ radars this year. We note that larger funds have a higher equity (including property) backing ratio (49%) compared to smaller funds (28%). The difference in the equity backing ratio between larger and smaller funds exists for open funds and is exacerbated by closed funds.
It has been pleasing to note the proportion of funds being managed using sustainability targets or criteria has increased again this year. Most of this increase has come from smaller funds, suggesting they have begun to learn from, and catch up with, their larger peers.
Sustainability
Our analysis suggests there is scope for many funds to review their asset allocations to increase their expected returns over 2023 by 50-100 bps without increasing the volatility of their portfolios. However, we do recognise that managing the investments of a with-profits fund is complex and has multiple dimensions and constraints that cannot be shown on an efficient frontier.
Efficient frontier
Funds that have used multiple asset managers or an in-house team (to manage separate asset classes) have outperformed those using a single asset manager by 0.8-0.9% p.a. over the last five years. This supports the theory that accessing specialist managers for each asset class or establishing a high-quality internal team can lead to greater returns.
Manager approach
This report is accompanied by an interactive Tableau dashboard. Participating firms are given secure online access and can use the dashboard to review results in more detail than presented in this report, and to carry out their own bespoke benchmarking analysis. Find out more here.
Interactive Tableau dashboard
This investigation covers 68 funds across 24 insurers, which provided information on their asset allocations and investment performance
to us privately.
We have split the analysis in this investigation by fund, as different funds within an insurer can have materially different risk characteristics. We have grouped funds by fund size and whether the fund is open to new business as set out in Table 1. The distribution of funds by size of total with-profits assets as at 31 December 2022 is illustrated on a logarithmic scale in Figure 1 below.
Grouping of funds
The data we’re reporting on
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Figure 2 shows the average asset allocation for assets backing asset shares split by size classification. Figure 3 shows how the average asset allocation across all funds has changed from 31 December 2021 to 31 December 2022.
Like last year, we have asked firms which risks they think are likely to change the asset allocation over 2023, and how they anticipate the exposure to each asset class may change over 2023. Figure 4 shows how fund allocations to each asset class are expected to change over 2023.
Asset allocation – assets backing asset shares
How funds were expecting to change their asset allocation within each asset class over 2022.
How fund allocations to each asset class are expected to change over 2023.
How funds are expecting to change their asset allocation within each asset class over 2023.
Figure 5 shows what firms view as the key risk that would influence asset allocation over 2023, and how this compares to their view over 2022. The risks noted by participants in the 'other' category included concentration risk and active management of funds.
Figure 6 shows the average asset mix for those funds that provided
a separate asset mix for their other with-profits assets, compared
with the average asset mix for the assets backing asset shares for those funds.
Around half of the large funds reported a separate pool of with-profits assets not backing asset shares, compared to less than 35% of the remaining funds. This implies that smaller funds are more likely to be managed with a single investment strategy covering all assets in the fund. As expected, the other with-profits assets were invested predominantly in fixed interest assets and cash.
Asset allocation –
other with-profits assets
Discover more
Interactive Tableau dashboard
Our interactive Tableau dashboard allows users to analyse:
Asset allocations split by open/closed funds and/or by fund size.
Variation in asset allocations around the
mean using box plots.
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On average, most funds have increases in cash allocations, which has been offset by a general decrease in gilt allocations. Interestingly, we saw no significant variation in the propensity for closed funds to adopt a separate asset mix when compared with open funds. However, we did note that for closed funds, the amount of other with-profits assets allocated to cash was four times the allocation in open funds.
The purpose of the other with-profits assets might vary slightly from firm to firm, but typically it is to provide the capital of the fund, to absorb losses under stress and (for open funds) to finance the capital strain on new business. The other with-profits assets are predominantly invested in safer assets such as fixed interest assets and cash.
There is a stark difference in the investment mix between the two pools of assets, reflecting their different purposes. The purpose of the assets backing asset shares is to deliver a return for policyholders in line with their reasonable expectations and attitude to risk.
Our insight
Figure 7 shows the average return on each asset class across all funds in the survey ,in comparison to an appropriate index. The indices used are set out in Table 2. Note that no index return is shown for 'other’, due to the diverse nature of this asset class.
Investment returns by asset class
Our interactive Tableau dashboard allows users to analyse:
Results split by open/closed funds, by fund size or both.
Variation in investment returns around the mean using box plots.
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Interactive Tableau dashboard
Discover more
Examples include:
It is also important to note the benchmark shown is chosen by us, and funds may be managing to a different benchmark. There may be valid reasons for the average performance being different to the benchmarks shown.
Regardless of size, and open/ closed status, the majority of funds achieved a negative return on all but the cash and other asset classes. However, this in isolation does not provide a full picture. The benchmarks used achieved a negative return on all asset classes, with exception of UK equity and cash. It is pleasing to note the average returns on with-profits assets have exceeded the benchmarks for all asset classes, except UK equity.
Our insight
For overseas equity, it may reflect a different portfolio composition between different overseas markets relative to the index, as there was considerable variation between different markets over the year.
For fixed interest assets, it may reflect that the assets held may be of a different duration than the average duration in the index.
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Our interactive Tableau dashboard allows users to analyse:
Returns on specific asset classes rather than total returns.
Results split by open/closed funds as well as, or instead of, by fund size.
Variation in investment returns around the mean using histograms and box plots.
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Interactive Tableau dashboard
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The spread in returns over one year has been approximately 25%, with the highest return being just less than -0.5%. There is no clear trend between the performance of funds by size. Overall, closed funds underperformed open funds. The key driver to this has been relative exposure to gilts, which has been the worst performing asset class.
Figure 10 shows that large funds have, on average, performed better than other fund sizes over the most recent five-year period, with individual annualised fund performance ranging between +3.9% and -3.6%.
All funds achieved a negative return over a one-year period. This reflects the general contraction of the global economy with the key themes affecting investment returns over 2022 being:
Our insight
The Russian invasion of Ukraine, with the impact of escalating sanctions on trade flow and commodities.
Central banks response to inflation and tightening of monetary policy.
Ramping up of Covid-19 within China during H1 of 2022, with the consequential impact on global trade.
UK Fiscal growth plan in September 2022 and the temporary impact on gilt yields and credit spreads in the UK.
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Sustainability considerations (also referred to as Economic, Social and Governance or ESG) are becoming increasingly important in investment management, in response to both regulatory pressure and consumer demand.
Figure 11 shows, at a high level, how much of a fund’s assets are subject to sustainability targets or criteria. Table 3 sets out several approaches that could be used to set sustainability targets and criteria. Figure 14 shows a breakdown of the proportion of funds using each of these approaches. Funds can use multiple approaches.
Sustainability
Of the different possible approaches to sustainable investment, screening is the most common, used by 74% of all funds and 89% of funds that have a sustainability target or criteria. The climate-aware approach is the most sophisticated approach, and it is the Prudential Regulation Authority’s (PRA’s) metric of choice. It is becoming more widely used, with 60% of funds in our analysis using it this year, compared to 33% last year.
The proportion of funds that apply sustainability targets or criteria to at least some of their funds was similar for open and closed funds, which suggests that sustainability is seen as more than just a selling point for new business.
82% of funds are managed with at least some of their assets having a specific sustainability target or criteria (2021: 71%). These targets and criteria have historically always been more prevalent among the larger funds. This is still the case this year, however the proportion of smaller funds that are using these targets and criteria has significantly increased from last year.
Our insight
Our interactive Tableau dashboard allows users to analyse:
Results split by open/closed funds and/or by fund size.
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Interactive Tableau dashboard
Discover more
Sustainable investment
For more information on sustainable investment, please visit our ESG Investing hub.
Figure 13 shows the efficient frontier for the asset shares for a balanced with-profits fund. We have overlaid the expected returns and volatility of returns for each fund in our survey. The chart also shows the return/ volatility of a 100% investment in each asset class.
Table 4 sets out our return and volatility assumptions for each asset class, and Table 5 sets out our correlation assumptions between each asset class.
Efficient frontier
Our interactive Tableau dashboard allows users to analyse:
Results split by open/closed funds and/or by fund size.
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Interactive Tableau dashboard
Discover more
Overall larger funds appeared to have larger risk appetites with larger allocations to growth assets, which suggests that asset volatility is less of a significant risk for them. This is consistent with large fund responses in the asset allocation section of this survey. There is a much wider spread in expected volatility in the smaller and mid-sized funds.
There may be valid reasons for funds to be below the efficient frontier.
Our expectation is that most funds will set their asset allocations by defining their risk tolerance, and then selecting the optimum portfolio that maximises the expected return within the risk tolerance.
From our analysis, a small number of funds are on, or are very close to the efficient frontier. However, most funds are below the frontier, suggesting they could increase their expected returns without changing their overall volatility.
A handful of funds appear far from the frontier.
Our insight
2022 has been a turbulent year for investment performance, different funds may have different views on future expected returns, and volatilities; particularly if the duration of their liabilities are materially different.
Furthermore, funds will have a more detailed understanding of their 'other’ assets and so can take this account in their analysis.
The transition costs for rebalancing may be too high relative to the increase in return.
Funds may have other management metrics that are not captured in this analysis, for example, liquidity levels, solvency capital requirement coverage, or diversification between geographies/industries.
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appoint a single investment manager to manage their investments;
appoint multiple managers, typically with different managers managing different asset classes; or
manage their investments using an in-house team.
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Funds have a choice as to whether they:
Manager approach
This year, we have extended our survey to understand which approach funds are taking for managing their equity and bond portfolios.
Figure 14 shows the five-year unweighted average investment returns for equity and bond asset classes, split by approach taken. The total bars show the aggregate average five-year total returns for 48 funds where we have the manager breakdown. The equity and bond returns are shown for 17 and 20 of these funds, respectively, where we have the five-year breakdown of returns by asset class.
Our interactive Tableau dashboard allows users to analyse:
Differences between funds managed by a single manager, those managed by multi-managers and those using an in-house team.
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Interactive Tableau dashboard
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Our survey data shows that using an in-house team, or using multiple managers outperformed funds using a single manager. The difference in performance at a total level between an in-house approach and using multiple managers is minimal. This supports the theory that accessing specialist managers for each asset class or establishing a high quality internal team can lead to greater returns.
The results above are based on the data available to us.
On the other hand, using multiple managers:
Using an in-house team, or a single manger to manage investments will usually be less expensive for funds. This approach would typically require less governance (once set up) and will typically have more efficient downstream processes as there is a single data source for investments.
Our insight
enables specialists for each asset class, which could lead to superior investment performance;
diversifies manager risk; and
diversifies investment style bias.
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Data and analytics
Manager approach
Investment
returns
Asset
allocation
The data we’re reporting on
Executive
summary
Sustainability
Efficient
frontier
Different funds have a wide range of different asset allocations, although most could be described as balanced funds with a mix of all the major asset classes. A wide variety of different types of assets were included under 'other'. This did not appear to differ by fund size and seemed to range from private equity to derivatives to holdings in collective investments that cannot easily be split into their component asset classes.
On average, larger funds tend to hold a higher proportion of riskier assets such as equities, whereas smaller funds tend to hold more fixed interest assets. The allocation to riskier assets in large open funds is relatively similar to the allocation in large closed funds. Smaller closed funds typically have a higher fixed interest allocation compared to larger
closed funds.
Our insight
At an aggregate level, the observed change in asset allocation is an overall increase in gilts and cash, and an overall decrease in equity, property and corporate bonds. However, underlying this, we have seen that many individual funds have the opposite changes (e.g. decrease in cash and gilts, and an increase in equity, property and corporate bonds). There is no clear correlation between the change in allocations and the fund size and open/ closed status.
We have compared the expected changes in asset allocation over 2022 against actual changes in allocation over 5%. There does not appear to be a strong correlation, suggesting that either changes in allocations have been less than 5%, changes have been masked by volatile market movements, or plans to change allocations have been put on hold during last year’s volatility.
More than half of funds expect their asset allocation to change over 2023. The general trend is for most funds to:
The Russia-Ukraine war is ongoing and has likely played a role in funds selecting geopolitical risk as one of the top three risks.
For smaller funds, the asset volatility risk is viewed as a bigger risk driver to asset allocations than asset value. The opposite is true for larger funds. This suggests that smaller funds may be seeking to make asset allocation decisions to smooth investment returns over time, whereas larger funds are investing more in growth assets in an attempt to maximise returns over the medium term.
Many more funds view central bank actions and domestic political risk as a risk driver to asset allocations compared to last year. This is likely driven by the UK government’s September 2022 fiscal growth plan, and the Bank of England’s response to inflation.
Decrease allocations to UK equity, property and cash.
Increase allocations to overseas equity and other.
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There seems to be a mix of views on allocations to corporate bonds and government bonds, with some funds expecting to increase these allocations, but with slightly more funds looking to decrease allocations. Surprisingly, more open funds are looking to increase these allocations, and more closed funds are looking to decrease these allocations.
The majority of funds of all sizes viewed geopolitical risk as one of
the top three risks to affect asset allocations over 2023.
Figure 8 shows the investment returns achieved in 2022 on assets backing asset shares by fund, ordered from highest return to lowest return. Figure 9 shows the average investment return achieved in each of the last five years by fund size classification and Figure 10 then shows how this translates in relative performance over a five-year period.
Fund-level investment returns
Performance attribution into asset allocation and stock selection.
Rankings of investment returns over periods of one, two, three, four or five years.
Cumulative investment returns over periods of one, two, three, four or five years.
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The return and volatility assumptions have been set using the results of our Economic Scenario Model as at 31 December 2022, calibrated over a 10-year time horizon, with an overlay of expert judgement. We have insufficient information to set a return and volatility assumption for the 'other’ asset class. Where a fund has 'other' assets, we have allocated these investments to equity, property, cash and fixed interest in proportion to its existing allocation.
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Executive summary
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The data we're reporting on
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Asset allocation
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Investment returns
05
Sustainabilty
06
Efficient frontier
07
Manager approach
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Our experts
Table 1: Fund classifications used in this investigation
Figure 1: Total with-profits assets by fund (ranked)
Figure 2: Asset allocation for assets backing asset shares as at 31 December 2022
Figure 3: Aggregate changes in asset allocations from 31 December 2021 to 31 December 2022
Figure 4: Expected changes to asset allocations over 2023
Figure 5: Top risks likely to influence asset allocation over 2023
Figure 6: Asset allocation for other with-profits assets compared with asset shares as at 31 December 2022
Figure 7: Investment returns by asset class compared with index returns
Table 2: Indices used by asset class
Figure 8: Investment returns in 2022 by fund (ranked)
Figure 9: Investment returns by year and fund size classification
Figure 10: Investment returns by size classification over five years
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Figure 11: Proportion of funds that apply a specific sustainability target or criteria to all, some or none of their assets
Table 3: Possible approaches to sustainable investment
Figure 12: Proportion of funds using each approach
Figure 13: Funds plotted on the efficient frontier
Table 4: Expected return and volatility assumptions for each asset class
Table 5: Correlation assumptions between asset classes
Figure 14: Five-year average investment returns
Investment performance and strategy
Participating firms
Our interactive Tableau dashboard allows users to analyse:
Asset allocations split by open/closed funds as well as, or instead of, by fund size.
Variation in asset allocations around the mean using box plots.
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Interactive Tableau dashboard
Discover more
Anticipated change in asset allocation by open/closed funds as well as, or instead of, by fund size.
Risks likely to influence asset allocation by open/closed funds as well as, or instead of, by fund size.
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100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
L
M
S
XS
UK equity
Overseas equity
Property
Corporate bonds
Goverment bonds
Cash
Other
17%
25%
8%
22%
14%
4%
11%
11%
20%
5%
25%
28%
4%
7%
10%
12%
6%
24%
27%
6%
15%
17%
13%
4%
30%
27%
6%
3%
3.00%
2.00%
1.00%
0
-1.00%
-2.00%
-3.00%
-4.00%
UK equity
Overseas
equity
Property
Coporate
bonds
Government
bonds
Cash
Other
-0.8%
-0.7%
-1.2%
-3.3%
2.4%
1.7%
1.9%
UK equity
Overseas equity
Property
Corporate bonds
Government bonds
Cash
Other
Decrease
Increase
-50%
-40%
-30%
-20%
-10%
0%
10%
20%
30%
40%
50%
60%
6%
44%
33%
39%
41%
8%
47%
52%
8%
8%
25%
22%
5%
33%
70%
60%
50%
40%
30%
20%
10%
0%
Geopolitical
risk
Asset / market value risk
Central Bank actions
Asset / market volatility risk
Climate related factors
Liquidity
Domestic political risk
Other
1st most likely
2nd most likely
8%
16%
36%
36%
10%
7%
XS
S
M
L
> 1,000
200 – 1,000
75 – 200
< 75
6
6
6
7
12
10
11
10
18
16
17
17
Classification
Fund size (£m)
Number of
open funds
Total number
of funds
Number of
closed funds
34%
13%
3%
33%
7%
9%
24%
9%
5%
23%
2%
25%
2%
Asset shares
Other assets
UK equity
Overseas equity
Property
Corporate bonds
Goverment bonds
Cash
Other
100%
80%
60%
40%
20%
0%
-20%
13%
20%
25%
22%
5%
8%
4%
3%
3%
41%
27%
-2%
Index
UK equity
Overseas equity
Property
Corporate bonds
Government bonds
Cash
Other
Asset class
FTSE All Share Index
FTSE All World (ex UK)
Index
IPD UK All Property
Index
iBoxx Non-Gilts All Stocks Index
FTSE Gilts All stocks Fixed Interest Index
Bank of England
Base Rate
N/A
20.0%
15.0%
10.0%
5.0%
0.0%
-5.0%
-10.0%
-15.0%
2018
2019
2020
2021
2022
Investment return on assets backing asset shares
3rd most likely
L
M
S
XS
Years
2.5%
2.0%
1.5%
1.0%
0.05%
0.0%
-0.0%.
Investmentn return on assets backing asset shares
2.2%
0.7%
0.3%
0.0%
L
M
S
XS
Size classification
*We have used the information provided without any independent verification, although we have queried responses where these looked to be outliers. Where a small amount of data has been missing from our data request, we have populated it to be internally consistent with other data provided. Where this has not been possible, or where there have been large amounts of data missing, we have asked the survey respondent for clarification.
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5.0%
0.0%
-5.0%
-10.0%
-15.0%
-20.0%
-25.0%
-30.0%
-35.0%
-40.0%
UK equity
Fund returns
Index return
Overseas equity
Property
Corporate
bonds
Government
bonds
Cash
Other
-3.6%
-7.7%
-7.8%
-7.7%
-10.4%
-18.4%
-14.1%
-33.6%
-17.2%
0.4%
0.1%
2.5%
0.3%
All
Some
None
72%
10%
18%
Certain sectors are excluded from the portfolio (e.g., coal)
Certain assets are favoured, using metrics such as ESG ratings
Portfolio is selected to align to specific climate targets
Climate aware
Carbon reduction
Tilting
Screening
Approach
Description
Proportion of funds using approach
80%
70%
60%
50%
40%
30%
20%
10%
0%
74%
60%
56%
59%
Screening
Tilting
Carbon reduction
Climate aware
Name
UK equity
Overseas equity
Property
Corporates
Cash
Government
7.50%
7.75%
6.50%
5.50%
2.50%
4.00%
19.0%
20.0%
15.0%
10.0%
1.0%
7.5%
Expected return
Volatility
UK equity
Overseas equity
Property
Corporates
Cash
Government
UK equity
Overseas equity
Property
Corporates
Cash
Government
100%
75%
50%
50%
0%
25%
75%
100%
50%
50%
0%
25%
50%
50%
100%
25%
0%
25%
50%
50%
25%
100%
0%
25%
0%
0%
0%
0%
100%
0%
25%
25%
25%
25%
0%
100%
AEGON
Chesnara
Cirencester
Dentists' Provident
DG Mutual
The Exeter
Foresters Friendly
Foresters Life
Healthy Investment
LV=
M&G
Metfriendly
National Friendly
NFU Mutual
Phoenix
PG Mutual
Royal London
Scottish Friendly
Sheffield Mutual
Scottish Widows
Shepherds Friendly
Unity Mutual
Zurich
Wesleyan
Carbon emissions data is used
to exclude heavy polluters
About us
Cash
Government bonds
Corporate bonds
Property
Overseas equity
UK equity
25%
8%
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READ OUR INSIGHT
All with-profits funds experienced a negative return, with the average return being -11.7%. While this sounds bad in isolation, the wider economic environment should be taken into account, and we note that on average, with-profit funds outperformed our benchmarks for most asset classes.
Investment returns
Funds that have used multiple asset managers or an in-house team (to manage separate asset classes) have outperformed those using a single asset manager by 0.8-0.9% p.a. over the last five years. This supports the theory that accessing specialist managers for each asset class or establishing a high-quality internal team can lead to greater returns.
Manager approach
01
Executive summary
02
The data we're
reporting on
03
Asset allocation
04
Investment returns
05
Sustainability
06
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