A guaranteed risk

The claims made for some growth bonds are not always what they seem

Be warned. Those headline-grabbing guarantees seen in advertisements for growth bonds are not always what they seem. Even after the recent rises in interest rates, the best returns savers can get from the banks and building societies are under 6.75 per cent on 90-day notice accounts. With these accounts, as with any deposits, income tax has to be paid on the interest.

Yet savers are being tempted by some so-called "guaranteed" bonds offering over 10 per cent free of tax to basic-rate taxpayers if they invest their money for five years or more. Only after reading the small print do you discover that the guarantee is only a partial one. It is indeed possible to get this sort of return but only if the FT-SE 100, or some other stock market index which may or may not be a UK one, does not fall over the investment period.

This is a high risk. It's quite true that -as the marketing folk are keen to remind us - there has not yet been a five-year period that has seen a fall in the FT-SE 100 since it was introduced in 1984. But other indices which have been around much longer, such as the FT-SE All Share, a much more widely based measurement of equity price performance, have seen falls over such a length of time.

These offers of high-income bonds, to give them a more appropriate name, come and go with great rapidity. Some of the better-known insurance companies, as well as some not so well-known, make regular offers of them. These have included Abbey Life, Friends Provident, General Accident, Scottish Life International, Eurolife, Swiss Life, Hamilton Life, Millennium Life and Financial Assurance.

They all depend on stock market performance to ensure a full return of capital. In some cases, it will be a combination of one of the UK Stock Exchange indices and an overseas index such as the S&P 500 in the US, the Nikkei in Japan or the Dax for Europe.

If the chosen index fails to reach the target, then income taken during the life of the bond will eat into the capital. Quite often, the small print reveals that if this should happen, the saver could get back only half the original capital investment at the end of the period.

These bonds invest anything up to half their funds in buying annuities to provide the income. In order to return the capital, the rest is invested. Instead of putting the funds in gilts, as is done by the lower-yielding but more traditional guaranteed income bonds, they invest in derivatives such as options - a high-risk strategy.

Both the Personal Investment Ombudsman Bureau, and the Personal Investment Authority itself have expressed concern over the high level of complaints they receive from investors in these high-income bonds who experience a reduction in their capital. A recent report from the Ombudsman stated that the lack of adequate information about the high risks attached to these bonds was being given to savers.

Some independent financial advisers including Towry Law have gone as far as refusing to recommend them unless the client absolutely insists on purchasing one. Unlike high-income bonds, traditional guaranteed income bonds are currently offering what appear to be lower interest rates with a full return of capital irrespective of what happens in equity markets. Money invested in these bonds is locked up at the particular interest rate for the investment period. Among the current crop on offer, GE Financial Assurance is paying a fixed 5.85 per cent net of tax for pounds 5,000 or more invested for a year, 6 per cent for two years, while ITT London & Edinburgh will pay 6.3 per cent for pounds 3,000 or more over three years and 6.6 per cent over five years.

If interest rates continue to rise, and forecasters expect them to go up to 7 per cent this year, it will be worth putting off an investment as the rates on offer from these bonds will also go up. Many investors are attracted by income bonds. The guarantee of a fixed income free of tax at a higher interest rate than from a conventional deposit account has great appeal. But it pays to read the small print. The bonds which pay very high rates are not as risk-free as you might thinkn