• Solly Tsie - Head of Research: Investment

Smoothed bonus portfolios: All you need to know


Smoothed bonus portfolios are investment portfolios, offered by life insurers, that provide a guarantee on the money invested into the portfolio and the returns passed on to investors in the form of bonuses declared by the insurer. Sometimes these portfolios only provide a partial (less than 100%) guarantee.


Generally, people who invest in smoothed bonus portfolios are conservative investors, who expect to be shielded from negative returns, especially in times of market stress like we have experienced recently.


The recent unexpected negative bonus declarations in April 2020 by Old Mutual and concerns around a number of smoothed bonus portfolio funding levels dropping to as low as 80% and 85% in March 2020, have raised questions as to whether these portfolios can continue to deliver on their expectations. This also begs the question, should future contributions from investors be directed elsewhere, while the funding levels are well below 100%?


What can we expect from smoothed bonus portfolios in the next year or so?


The graph 1 shows that there is a strong correlation between the funding level of a typical fully vesting smoothed bonus portfolio, and subsequent 12-month returns.


When the funding level dropped below 100%, investment performance over the next 12 months was disappointing, even when compared to cash. This is because a smoothed bonus portfolio declares smaller bonuses when the funding level falls below 100%, in order to build up reserves and improve the funding level.

The reduced funding levels as of late are expected to result in lower bonuses (even lower than cash returns) in smoothed bonus portfolios, at least for the next 12 months, even if investment markets recover.


If I have invested my money in smoothed bonus portfolios, what should I do?


The expected low future bonuses may cause some investors to consider switching out of smoothed bonus portfolios. However, investors need to be aware that insurers will impose a market value adjustment penalty on investors who switch out of smoothed bonus portfolios when the funding level is lower than 100%, unless this switch is deemed to be a “benefit payment”.


For example, if a smoothed bonus portfolio is 90% funded, an investor who switches out of the portfolio may be subject to a 10% market value adjustment. The penalty protects the investors who stay invested in the portfolio. If a large group of investors is allowed to withdraw from the smoothed bonus portfolio without the market value adjustment, this would result in a further deterioration of the funding level.


Typically, a benefit payment that allows for the market value adjustment to be waived includes a withdrawal from a retirement fund because of a termination of service or retirement, and monthly income withdrawals for pensioners with living annuities. There may also be special individual member switching conditions that allow for a very limited number of investment switches at full value out of a smoothed bonus portfolio at specific dates.


It is clear that most investors should therefore remain invested in their chosen smoothed bonus portfolios.


However, there may be merit in considering a different investment portfolio for ongoing contributions until the funding levels recover. The decision on future contributions should be considered carefully, based on specific conditions (the size of the contributions, the number of members affected, the frequency of the contributions) and the funding level of the relevant smoothed bonus portfolio. There may also be other constraints such as member administration processes that do not allow for a different strategy to be adopted for ongoing contributions in a retirement fund.


Return profile of smoothed bonus portfolios


The graph 2 shows the investment performance of a typical smoothed bonus portfolio compared to a growth investment portfolio, with no smoothing of returns. The graph shows investment returns over rolling 12-month periods. The returns of the growth investment portfolio fluctuates much more than those of a typical smoothed bonus portfolio. Additionally, the smoothed bonus portfolio would have protected capital in times of negative market performance. Note the investment returns in the smoothed bonus portfolio have not been negative over the period considered. It is the return profile of the smoothed bonus portfolio that makes it attractive to conservative investors.

Recent investment performance of the smoothed bonus portfolios


The following table shows the investment performance of a number of smoothed bonus portfolios in the market compared with the average return of aggressive multi-asset portfolios (Wealth Creation) and conservative multi-asset portfolios (Capital Preservation) in the Retirement Fund Monitor. The investment performance applies over various periods to 31 March 2020.

The return profile above shows that smoothed bonus portfolios are doing their job well to protect investors’ capital in times of market stress. All the smoothed bonus portfolios included above have outperformed the average aggressive (wealth creation) and conservative (capital preservation) portfolios over all periods presented. This highlights the effective capital growth and capital protection ability of these portfolios.


Having said this, we need to consider the lag in the time it takes for the smoothed bonus portfolios to reflect the poor performance in the market and the underlying assets they hold. Often bonuses are declared a month in advance. So the returns above do not consider the drop in market values in March 2020.