Advisers take heat for annuities chill

Variable-annuity assets took a tumble during the first two quarters this year, and some analysts think they’ve found the culprits – financial advisers.

Analysts at Chicago-based Morningstar Inc., and elsewhere, are advancing that theory to make sense of the 6.5% drop in industry assets to $910 billion, at a time when mutual fund assets held steady at $6.9 trillion.

Large-cap stocks make up 73% of the Wilshire 5000 Index, but nearly 84% of variable-annuity and variable-life assets were invested in the sector through July, according to Morningstar.

The disproportionately large investment in growth portfolios has hit investors and the industry hard. Growth stocks declined 10.6% in the first seven months of the year.

“The biggest responsibility for this lies with financial advisers,” says Todd Porter, an investment consultant for Morningstar’s institutional group.

“They are the ones who have the expertise to build asset-allocation models and create diversified portfolios. I’m sure they get some pressure from investors to load up on hot funds and chase the market,” he adds. “That is what this evidence suggests is happening.”

“I think that is indicative of the entire investment spectrum, not just variable annuities” says Jana Waring Greer, president of Sun America Retirement Markets in Los Angeles. “We had a disproportionate amount of assets flow into high-beta technology stocks.”

Underweighted

Morningstar analysts point out that just one-half of 1% of variable-annuity and variable-life assets are invested in small-cap-value funds, even though such stocks represent 4% of the market.

Among this year’s best performers, they had risen 12.4% through July.

Some industry executives take a more moderate view, saying that the tax-deferred status and long-term investing horizon of annuities naturally leads to more-aggressive investments.

“We position annuities as a long-term retirement savings vehicle for a customer who has a seven- to 10-year time horizon,” says Merry Mosbacher, principal for insurance marketing at Edward Jones, a regional brokerage house in St. Louis.

“To the extent that someone would have put more money in an aggressive category than in growth and income, you can see that effect,” she adds.

Ms. Mosbacher notes that variable-annuity investments need to be seen as part of a customer’s overall portfolio. “We focus heavily on the need to diversify clients’ portfolios as a means of balancing risk. I would hope other firms do the same,” she says.

Half the brokerage house’s variable-annuity assets are invested in growth and income, and balanced accounts, according to Ms. Mosbacher.

Morningstar has yet to determine whether an overweighting in large-cap-growth stocks exists for mutual funds or direct-sold annuities.

Those findings are due to be presented in October during the annual meeting of the National Association for Variable Annuities.

However, Jag Alexeyev, a senior analyst with Strategic Insight Mutual Fund Research and Consulting LLC in New York, says that the patterns of investment in variable annuities are similar to those in the mutual fund business.

“You can’t make an argument that people are misallocating in sectors,” he says.

Mr. Alexeyev asserts that mutual fund assets have been less affected by falling stock prices because one-third of the assets are now in money market funds.

add-ons are slow

At the start of this year, money market funds represented 26.5% of mutual fund industry assets.

In contrast, 23% of variable-annuity assets resided in money market and fixed accounts, says Frank O’Connor, product manager at the Variable Annuity Research and Data Service in Marietta, Ga.

The fact that investors are putting less money into variable annuities could be another factor behind the industry’s shrinkage.

Through this year’s first quarter, variable-annuity net sales totaled $4.9 billion, about the same level as last year’s fourth quarter, but just over half the pace of last year’s first quarter, according to Financial Research Corp. in Boston. Second-quarter net-flow data will be available later this month.

“There is little new money coming in, and the assets are falling due to poor investment performance of funds,” observes Randy Miner, a variable-annuity analyst at FRC. “I don’t think the advisers are watching their clients’ investments as they should be.”

Mr. Miner notes that negative publicity over annuity fee structures in the last year also has cooled investor interest.

“With the markets not doing as well, and people having to pay out such high mortality-and-expense charges, there’s not much performance gain in purchasing a VA at this time.”

At Edward Jones, which oversees $26 billion in variable-annuity assets, sales had fallen 10% this year through August versus sales during the first eight months of last year.

And just 16% of the broker’s sales volume represents additional investments in existing contracts, down from 22% last year.

Ms. Mosbacher says that part of the decline in annuity sales may be tied to the growing complexity of annuity offerings.

“It’s simply easier to sell a mutual fund than a variable annuity today,” she offers. “There is no question that the additional features being offered have added complexity to the sales equation.”