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What is the Difference between Fund Switching and Premium Redirection?

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Sep 07, 2018

If you have an Investment Linked Policy (ILP), your allocated premiums are usually invested in various sub-funds chosen by you. The value of your ILP will vary based on how well those sub-funds are performing.

For this reason, it’s important to make sure you pick the right sub-funds for your ILP that best align to your financial needs and goals, investment goals and horizon, risk appetite and tolerance. Your Financial Adviser (FA) will usually provide guidance on this.

Sub-funds may invest into different asset classes, geographical regions, sectors - or a combination of these. For example, some funds invest only into stocks in the Asia Pacific region, some invest into technology stocks worldwide, and other invest into bonds in developed economies such as the United States (US).

The investment objectives across sub-funds in the same asset classes or regions may also differ, with varying levels of risk and returns. Your FA can advise you on the best match for your investment profile.

Fund switching

When you perform a fund-switch, you change the existing allocation of sub-funds in your ILP. To illustrate, we assume that your investment portfolio is currently invested 70 per cent in the US and 30 per cent in European markets.

If you decide prospects are negative in Europe, you may want to change the allocation to 90 per cent US and 10 per cent Europe, to protect your investment portfolio from the downsides of a struggling European economy. This change in allocation can be done through a fund switch.

However, the fund switch only affects the current allocation of your sub-funds. It is a one-off migration of assets that will not affect how your sub-funds are purchased in the future with your upcoming regular premiums. For that, you will need to do a premium redirection.

Premium redirection

A premium redirection alters where your future premiums will be invested. Borrowing the example above, you currently allocate 70 per cent of your premiums into US equity sub-funds, and the remaining 30 per cent into European bond sub-funds. This is how your premiums will be invested, each time the premiums are paid.

To change this allocation of recurring premiums (say you want to invest more into European bonds than US equities), you need to perform a premium redirection.

Unlike fund switching, a premium redirection does not change the existing composition of sub-funds in your investment portfolio. It only changes which sub-funds will be purchased with your future premiums.

When is fund switching used?

Fund switching is often used to:

- Capture better returns from momentary market shifts or to reduce exposure to investments that are expected to face significant headwinds over the near term

- Rebalance your portfolio

- Cater to significant life events or changes

1. Capture better returns from momentary market shifts or reduce potential losses in volatile periods

Before we explain this, we want you to know that it is a difficult task to try to time the markets. It’s not always a good idea to switch funds because you think you’ve spotted the next investment fad.

That being said, you might have it on good authority (e.g. your FA or wealth manager) that you can better capture gains with a quick fund switch.

Your FA may, for example, advise you to momentarily reduce your fixed income assets, since the sub-funds investing into these areas may be negatively impacted by the series of rate hikes planned by the American Federal Reserve in 2018, which cause previously issued bonds to yield lower interest rates than more recently issued bonds. As another example, the rising trade tensions between the US and China are expected to adversely affect certain companies or industries. Since many manufacturing firms are expected to cope with higher import taxes on both sides, you may be advised to switch out of funds with significant exposure to such firms or industries, to protect yourself from growing risks.

In contrast, your FA may also advise you to place a greater emphasis on technology stocks in the near term, to reap profits from investments into tech giants which have seen large gains on the back of strong earnings reports, such as Facebook and Amazon.

In the above scenarios, a fund switch is used to capture gains or reduce risks in the near term.

2. Rebalance your portfolio

The asset allocation in your portfolio needs to be maintained.

For example, you have $50,000 in your portfolio, and the planned allocation is 70 per cent equities (S$35,000) and 30 per cent bonds (S$15,000).

Let’s suppose the stock market had a bull (good) run. The value of your equities rises from S$35,000 to $45,000 (75 per cent), while the value of your bonds remain at $15,000 (25 per cent).

At this point, you may want to take profit from the equity portion and bring your portfolio back to the original allocation, by reducing the equity portion to $42,000 (70 per cent) and adding to the bonds portion to make it $18,000 (30 per cent).

Hold on, why would I sell off the better performing asset to buy more of the lower-performing asset? It seems counter-intuitive, we know - but it ensures that you keep to your asset allocation tailored to your desired risk tolerance. A sudden stock market crash could wipe out the bulk of your wealth and place your financial goals in jeopardy if you bear more risk than you should.

3. Catering to significant life events or changes

As you near retirement, your FA will usually advise switching to safer (lower-risk, lower-return) assets; such as bond-based sub-funds, or income-generating / dividend-paying assets. This is because you are reaching the end of your investment horizon, and cannot afford to take big risks with your nest egg (you don’t have time to replace any big losses).

You may also be faced with unexpected changes to your life, such as a retrenchment or substantial income reduction. A divorce, disability or long-term disease can also significantly impact your life.

Your financial situation, needs and goals may change in your new situation, and your investment portfolio should be reviewed to ensure it is still compatible with your adjusted risk profile.

When are premium redirections used?

A premium redirection is used to fundamentally change the way your premiums are invested. This sets the long-term direction of how your ILP will work for you. It is a disciplined process whereby you apply dollar cost averaging of the various sub-funds, whether the markets are bullish or bearish.

When are both fund switching and premium redirections used?

During significant life changes, you may be advised to use both fund switching and premium redirection to cope with the situation. This will change both your current investment holdings and future investment approach, to match your new financial goals and risk appetite.

As a word of caution, you shouldn’t make a habit of tweaking your investment portfolio / asset allocation mix without your FA’s input.

Investing can be analogous to baking a cake. If you keep opening the oven to poke at it, you will most likely end up with a ruined mound of sludge.

If you want to buy and sell assets to capture quick gains, it’s best to set aside an affordable amount for activities like stock trading. Do NOT use your ILP as your makeshift trading platform.

If you’d like to review your existing ILP or buy a new one, get in touch with AXA and speak to an financial advisor about our range of investment plans.

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