High-yield funds a popular choice

After they take the 25 per cent tax-free lump sum, what do recently retired investors look for in an Approved Retirement Fund (Arf)?

High-yield funds are popular with Arf clients, according to Alan Morton, a financial adviser at Moneywise Financial Planning.

These funds invest in companies that pay high rates of dividends to shareholders. The dividends can then be taken as income or reinvested.

High-yielding stocks tend to be solid performers rather than engines of spectacular growth and high-yield funds are therefore not the riskiest of fund options.

For Irish Association of Pension Funds (IAPF) chairman Joe Byrne, the situation is clear.

"If funds want to earn reasonable returns on their assets then they need to be exposed to equities," he says.

But equities, as evidenced on global stock markets this week, are volatile, with the result that an increasing number of Arf buyers are looking for funds that will guarantee their initial capital, Morton says. Guaranteed funds are not great at providing an income, however, he notes. They also usually have management charges that are about half a per cent higher than average.

"The real cost of the guarantee would come into play if we have a stock market correction. If there is a wobble of 15 per cent, say, a guaranteed fund will automatically switch into bonds, where it will stay until the bonds mature," says Morton.

Arf holders have total control over their investments and can more or less invest in anything as long as it is "at arm's length".

This means that they cannot invest in chattels such as paintings, jewellery, antiques, vintage cars and yachts, from which they might derive pleasure as well as tax efficiency.

Investors cannot use their Arf to buy a holiday home if they intend to use it themselves and they cannot buy or dispose of assets owned by relatives.

Property has traditionally been much sought after by investors, but Arf clients are now seeking out more diverse investments, according to Morton. "In the past, you could buy one three-bedroom apartment in Donnybrook and that was your Arf."

But the days of throwing large chunks of cash into one asset are over, he believes. "The wise investor is running away from Irish residential property."

The choice of assets very much depends on the type of investor, according to Ian Mitchell, managing director of Deloitte Pensions & Investments.

Someone with a substantial public service pension who is using an Arf for their additional voluntary contributions (AVCs) can afford to take an aggressive approach and opt for a high proportion of equities.

"If it goes down in value one year, they still have a very strong income stream," says Mitchell.

On the other hand, a retiring self-employed person with a modest personal pension to their name will want to be cautious, but not over-cautious enough to settle for an annuity. They will choose a significant holding in bonds, maybe placing some of the fund in commercial property.

Finally, high net-worth individuals with the maximum €5 million permitted for tax relief purposes in a pension fund will look for a full range of stock-specific, self-directed options.

In general, when choosing an Arf, investors will look to the overall strength of the company, fund performance and the charges on the fund.

Often the biggest expense will be the allocation rate - in other words, how much of the fund is actually invested and how much of it disappears in commissions.

"There is quite a margin on commissions on Arfs, so you would be hoping that the broker would pass that margin on," says Mitchell.

If the broker is getting an ongoing trail commission - for example, €2,500 a year on a €500,000 fund, or an annual commission of 0.5 per cent - Arf holders should expect a high degree of detailed investment advice for their money, he adds.

As with all major investments, time spent negotiating on charges at the outset will save Arf investors a scarily high amount of their hard-earned cash.