Investment Trusts: Going in to bat for second-hand endowment policies: Jason Nisse looks at benefits offered by a new investment idea

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WHEN Foreign & Colonial launched the first investment trust 125 years ago, one of the main principles behind it was that people want to invest in distant and obscure markets without having to research the different types of securities available or take the risk of having all their eggs in one basket.

By purchasing the investment trust, they could benefit from the specialist knowledge of the fund manager and have a spread of investments - reducing their risk without necessarily reducing their return.

This principle has one of its most interesting modern examples in the new area of investment trusts investing in second-hand endowment policies. So far there is just one trust - a pounds 30m fund launched by Kleinwort Benson last year. But a second, launched by Barclays de Zoete Wedd and managed by BZW Investment Management, is in the later stages of pre-marketing and will be formally launched next month, proposing to raise pounds 20m. There are also rumours of a third trust, from John Govett.

These funds are tapping into a fast-growing market in the trade of second-hand endowment policies that has developed over the past five years. They can give the investor an exposure to what looks like an exciting market without exposing him or her to the more dangerous of the risks.

The market for second-hand endowment polices has grown because of the inefficiencies of endowment policies themselves. If you take on an endowment policy, typically as part of an endowment mortgage, you are quite likely to want to surrender the policy before the end of its term. For instance, you may have a 25-year mortgage on your house and wish to sell the house after 10 years. At that time you would want to surrender the endowment policy and use the money to pay off part of your mortgage.

But the life assurance company that granted the policy does not always offer a good surrender value, and a market has grown up for investors who will buy those policies in the expectation of the return they can get from them when they mature. These investors will continue to pay your premiums until the policy matures and then will get the lump sum pay-out at the end of the policy life.

Sammy Alexander, managing director of Policy Portfolio, one of the largest traders in these policies, says typical investors would be people wanting to invest a lump sum for a good return in 10 years' time and averse to the risks of the stock market. These would often be self-employed people aged around 50 or expatriates who want to come back to the UK in 10 years' time. There is also interest from smaller company pension funds and charities, as well as increasingly from abroad, notably Germany, where the range of investment opportunities for wealthy individuals is quite limited.

These investors tend to buy through independent financial advisers who would buy the policies from the traders - which in addition to Policy Portfolio include firms such as Beale Dobie and Johnson Fry - or at auctions organised by a group called Foster & Cranfield.

But there is a problem investing in the policies. For a start, life assurance firms can unilaterally reduce the bonus pay-outs on endowment policies if they are having a poor time themselves. Then there is the matter of maintaining the policy by keeping up with the payments and making sure the person who took out the original policy is still alive - presumably by ringing them up to say hello.

Kleinwort spotted this problem and decided the way to address the market was through an investment trust. According to Simon White, managing director of Kleinwort's investment trust management, a trust could buy a spread of policies conforming to an investment criteria worked out by an actuarial commitee, and so would be able to compensate for the underperforming policies with those that did well.

Kleinwort's trust raised pounds 30m just over a year ago, mostly from professional investors, though there was an open offer raising pounds 7.5m. Some commentators have criticised Kleinwort because it has taken some time to invest the money - the trust is only 80 per cent invested now. Market experts say, however, that Kleinwort has not been slow - merely hindered by tight investment criteria, which meant it was restricted to buying policies that mature in the few months running up to 31 October 2003.

BZW will launch its trust, raising pounds 20m, next month. It is being registered in Jersey for tax reasons and will have a slightly larger range - buying policies maturing between 2000 and 2005. Dan Nathanson of BZW Investment Management, who will invest the money, does not envisage the same problems Kleinwort had and expects the trust to be fully invested within a year of launch.

But will the flow of new money coming into the market through these trusts push up the prices of endowment polcies and make the market less attractive? After all, there is already pounds 50m of new money from the trusts chasing a market that last year only had a turnover of pounds 60m.

Mr Nathanson says it will not. He argues, and he is supported by Mr Alexander, that the second-hand endowment policy market is growing as more people realise there is an alternative to early redemption of the policies. Estimates vary, but it is likely that turnover this year could be anything between pounds 80m and pounds 100m, and the potential market for second-hand policies could be in the region of pounds 500m to pounds 1bn.

Mr Alexander believes there is plenty of room for the BZW trust, and there is probably room for the Govett trust if it is launched. But beyond that he reckons that new professional investors will push up the prices and destroy the attractiveness of the market.

Investors in these trusts have to get in quick, before the train leaves the station.

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