This PWITip is designed to give you a broad view of risk, and a proposal on mitigating this risk as well as maximising the return by adopting a broad investment strategy. Although we try to assess the risk associated with particular investments, perception of risk is very personal and hence our opinion must be regarded as subjective. It is important that all investors try to make that subjective judgement for themselves. It is an adviser's job to point out both sides of the argument for each type of investment and help the investor make appropriate choices. Perhaps, the adviser's most important job is to make sure the investor can sleep at night! For example, warnings are given that equity prices can fall as well as rise (THIS IS NOT A RISK - IT IS A CERTAINTY). Prices do indeed fall as well as rise, leaving an investor in a potentially dangerous situation of perhaps having to encash investments when they are low.

Risk Profile
The following factors should be considered as they can all influence and have an effect on your investment(s):

• Political
  Investments can be affected by political instability, a change of government, or a government policy change either at home or abroad.
  
  
• Interest Rates
  Particularly relevant to fixed interest investments and bonds, an unexpected rise in interest rates will result in a fall in value in real terms of the investments - the converse is also true. Variable interest rate investments are directly affected, as a drop in the interest rate will result in lower returns.
  
  
• Inflation
  All investments suffer from the effects of capital erosion.

  As an idea, $1,000 will be worth

  Rate	5yrs	10yrs	15yrs	20yrs
  5%	783	614	481	377
  10%	621	389	239	149
  15%	497	247	123	61

  
  
  
• Exchange Rates
  If an investment includes a foreign element, then its value is vulnerable to exchange rate movements.
  
  
• Business
  Long-term industrial change and economic uncertainties, although difficult to evaluate, influence the risk profile.
  
  
• Market
  This is associated with the market value of particular investments, e.g. predictions of future corporate earnings and dividends, reputations of management teams, etc., in addition to the general attitude and sentiment of investors.
  
  
• Time
  The relationship between risk and the length of time an investment is held is directly proportional. Generally, the longer the investment is held, the lower the risk profile, although the nature of the investment will have a significant bearing.
  
  

In the current climate, with the US market apparently self-correcting, Europe slowly running out of steam, the Asian crisis continuing to plummet, as does the Australian dollar, emerging markets not emerging, Russia remaining Russian, and the Far East showing no signs of any pick-up, where can the investor turn? Perhaps to…

With Profits Bonds

With profits funds have been with us for a long time, but most investors probably know them as endowment policies. The difference between a with profits bond and a traditional endowment policy is that instead of regular monthly contributions being paid into the fund, a lump sum single contribution can be made. In fact, whether monies come in on a regular basis or in the form of a lump sum, all investments end up in the same pot. That underlying portfolio will vary in structure between different insurance companies but broadly it is likely to have between about 25% and 75% of the fund invested in equities with perhaps between 15% and 30% in property and the balance made up of fixed interest securities and cash. Over the years these investments should grow, and historically that growth rate has centred on a return somewhere in the low teens per annum. However, as with any investment largely concentrated in equities and property, there are going to be good years, bad years and indifferent years. This is where with profits funds differ from other collective investments. With investments such as unit trusts and investments trusts etc, the price of your holding will vary much in line with the fortune of the underlying investments on a day-to-day basis. However, a with profits bond is different in that during a bad year, the insurance company will dip into its reserves that it has built up over many decades to bolster the return. Then, in a good year, it will not pay out the full gain, but use it to replenish the reserves. This means that an investor can look for a fairly steady return every year.

In effect, this return is made up in two ways. Every year the insurance company will normally add a bonus (the Reversionary Bonus) to your holding. This is a fairly steady return as historically bonus figures do not tend to vary drastically, although occasionally the insurers do get a little ahead of themselves and push up the annual bonus too high and then have to cut them slightly at a later date. These bonuses are accumulative, so if in year 1, a bonus of 10% were declared, an investment of $1,000 would increase to $1,100. If the following year's bonus is also declared @ 10%, the new total is now $1,210.

The second type of bonus is called the Terminal Bonus, which is not guaranteed. This is paid on either death or when the bond is sold. Insurers declare a terminal bonus each year, so the overall return is easy to calculate. As an example, the terminal bonus may be 2% for each year the bond is held in force, hence after 5 years, the terminal bonus would be 10%. Overall, as a broad example, if annual reversionary bonuses had been declared @ 10%pa, with a further additional 10% after the bond had been held for 5 years, the average annualised return would be 12% ignoring any effects of compounding. However, different companies comply with different rules about their terminal bonus. Some award them from the outset, while others penalise the "early surrender" policyholder by only awarding them when the bond has been held for a period of time, normally 2 to 5 years.

However, although eligibility is not attained until after say 2 years, this is not to say that the bonus for the first 2 years is lost. It simply means that the bonus is not awarded if the bond is sold too early.

Purchase / Sale
These types of bond can be sold or purchased on any business day. They do not suffer huge penalties for early surrender, although most do levy a charge if the bond is encashed in the first few years (please c/f the section on Market Value Adjustment below). Notwithstanding any particular conditions attaching to the relevant bond (details of which will be in the Policy Conditions, a copy of which should always be read), as there is no fixed term on these bonds, they could be sold the day after purchase, or held until death. It is our opinion however, that a medium-term view should be taken, a 5-year term being about par for the course, particularly if an income will be taken. As most carry a front-end load of some 5%, if an income is to be taken, the bond should be held for a few years to ensure the front-end load is covered.

While the annual bonus can be regarded as pretty secure and stable, the terminal bonus can be quite variable, and during a particularly poor period may not be declared at all. For this reason it is important to be flexible about the time of the sale. Please carefully consider contemplating holding onto the bond instead of cashing in during a particularly bad time - as always it is a good idea to seek professional advice.

Market Value Adjustment (MVAs)
In the small print of these contracts, the above term is referred to. In simplicity, this means that the company will pay out less than the full value of your investment in particularly adverse market conditions. Now, some commentators see this as a negative point, but we consider it as a method of protecting those investors who last the course. It should be regarded as a protection against those individuals taking unfair advantage of the insurer's use of the reserves to protect investors during a period of poor investment returns. If investors use these bonds sensibly and invest reasonable amounts in them, it would be wholly unfair should other investors sell to take advantage of say low stock prices as this would reduce reserves, in turn reducing the security for the remaining investors. Hence, we regard MVAs as a protection for individuals who want the advantages of regular and stable growth offered by with profits bonds, without resorting to abuse of the system. If cash was needed for short-term needs during a time of low investment returns, alternative sources should be tapped (for example cash held on deposit), which could then be replenished when times return to normal. The use of MVAs is used incredibly infrequently, and should therefore not pose a problem for investors who manage their affairs appropriately.

Advantages:
This type of product achieves regular, steady growth, usually above that offered by deposit rates (with far greater security) by smoothing out the fluctuations associated with stockmarket/property investments through the daily application of a Reversionary Bonus, with the likelihood of a Terminal Bonus at sale. It is considered to be a MUST HOLD investment in any portfolio with a view to balancing the portfolio, by reducing the overall risk and thereby increasing the overall return.

Disadvantages:
This investment product SHOULD NOT be considered as a short-term investment. A minimum of 5 years is recommended, as early surrender penalties do apply.

Risk Assessment
We regard with profits bonds as relatively low-risk. Their prices depend on the bonuses declared each year, these in turn being dependent on the performance of the underlying portfolio and the insurance companies' reserves. Broadly, the stronger the company's reserves and the more conservative the underlying portfolio, the lower the risk. Income is fixed at any level you decide, which can be changed if required.

THE FRIENDS PROVIDENT WITH PROFITS INSURANCE BOND
The skeletal facts:

1. The Company
   1. founded in 1832
   2. manages around $30 billion
   3. administers 2 million policies worldwide
   4. in 1984, pioneered "ethical" investment in the UK
   5. currently UK market leader holding 50% of entire ethical market
   6. a controlling interest in Friends Ivory & Sime with offices worldwide
   7. long-standing award-winning fund management track record
   8. in 1997, voted by professional advisers for most efficient offshore administration
2. The Product
1. The Fund provides the potential for capital through the addition of regular bonuses
2. There is an eligibility for a terminal bonus as well (subject to a minimum of five years invested)
3. Regular bonuses currently average 7.75% p.a. - in sterling (11.5% pa equivalent in US Dollars terms). Friends Provident track record takes this yield to 10.29% pa over 5 years and 13.07% pa over 10 years.
4. Minimum investment £5,000
5. The bid/offer spread, or initial charge, is 6% which PWI discounts down to 4% for amounts up to £50,000 or 2.5% if greater
6. There is no annual management charge
7. The charge equates therefore to 0.8% pa for 5 years for amounts less than £50,000 or 0.5% pa if greater than £50,000. This is cheaper than a mutual fund or unit trust!
8. Access is available at any time although the extra terminal bonus may be lost if taken before five years - Full encashment charge 5% reducing by 1% pa to zero after 5 years.
9. Bonuses reduce the exposure to volatility and once added cannot be taken away
10. Diversity into a 'With Profits' fund adds balance to your portfolio
11. Friends Provident International have achieved 31 out of a possible 40 Top 10 placings in the With Profits Survey 1998.

The With Profits Bond has an impressive past performance, and consistency (which plays a very important part in our Recommendations Review) is one of its strongest points - very rarely top, but always near the top. Although the future level of bonuses cannot be guaranteed, we believe that current bonus rates will be maintain comfortably above the returns offered by deposit rates, particularly as world markets move more and more out of equities and into bonds and fixed interest securities. This particular investment therefore is ideally suited either to the cautious investor seeking steady, secure consistent growth, or indeed for the more astute investor seeking either consolidation or perfecting the balance of their portfolio while looking for a slightly more bearish exposure.