A sure thing - or a certain risk?

`Guaranteed return' stock market products sound tempting to the more cautious investor, but beware, says Kim Hunter, the big promises depend on a lot of small-print provisos

If you go glazed-eyed over the choice between economy toilet rolls and the whole stitched-and-quilted hog, you haven't a cat in hell's chance of picking a "guaranteed" product without guidance.

For those who have missed the marketing blitz, there are 57 varieties of "guaranteed-style" products, but the basic idea is to "guarantee" your money back - or a percentage thereof, or an income - whatever happens to the stock market.

The aim is to give investors sick of low building society returns a taste of equity markets, but without too much of any associated risk. It is such an enticing idea that an estimated pounds 2.5bn was invested in them last year. But shop carefully: there are the details which the issuers keep for the small print.

Homework is compulsory. As Chase de Vere investment director Graham Hooper warns: "It sounds like a jungle, but it is worth spending your time before you spend your money. If it sounds too complicated, and is going to give you sleepless nights, then forget about it."

The most important factor to the marketing whizz is the headline rate - "156 per cent of FT-SE" in 6in letters on the front of the leaflet in dayglo orange. Given its hypnotic effect, all kinds of methods are employed to make this number bigger.

Remember, the bigger the headline figure, the greater the risk of the product not performing to your advantage. It may be a percentage of an average, rather than actual, stock market return. It might be that you will not get a bonus very often.

There are many types of guaranteed products. High income bonds, for example, sell themselves by offering a high headline rate of interest, which sometimes appears to come with a guarantee that the core capital sum will be safe. In fact, some estimate the likelihood of capital erosion to be as high as 50 per cent. Be aware that your 10 per cent a year can shrink to 7.5 per cent or lower if falling markets ensure the fund munches your capital.

Most brochure performance figures, which purport to show how unlikely it is for your capital to be eroded, concentrate on the recent past. However, as John Hibbert, director of financial consultants Barrie & Hibbert, says: "Our financial intuition is based on the experience of the markets over the past 20 years. In the context of the longer term, this period has done exceptionally well." Therefore, ask for simulations of past performance that go further back.

With so-called "rolling funds", which ensure you retain 98 per cent or so of the bid price of the fund every quarter (or six months, or some other period), be aware that this is not a 98 per cent guarantee. If the stock market falls over consecutive quarters you could lose a significant proportion of your investment. On the upside, however, gains are locked in regularly.

If a product pays a basic interest rate, with a bonus on top for each year that none of several indices falls (like the SLI Bonus Deposit Bond), ask to see some "probability statistics" covering this eventuality. Richard South, director of Midland Unit Trust Management, warns: "It doesn't take a genius to work out that if there is a risk of one index not performing, the risk from two or more indices must be greater."

Studies have, for example, looked at a six-year product based on a guaranteed return of 5.06 per cent per annum, plus simple interest of 17.25 per cent for each year. They have found that if neither the FT-SE nor the American S&P falls, the product is likely to produce an overall annual return of 8 per cent - around 1 per cent higher than a gilt of the same term. The chance of achieving 12.6 per cent per annum with such a product is a mere 2.8 per cent.

Many of these products stand out by their complexity. The Johnson Fry Hindsight 20/20 guaranteed bond entices by its international "Best of Three" approach. It will give you 50 per cent of the best performing market, 30 per cent of the next, and 20 per cent of the dud. Given that markets can go down, some of that exposure could be to falling markets. Still, there is the possibility of a significant upside.

With such a product, the estimated probability of an annual return of 15 per cent or more is 15 per cent; that falls to 5 per cent for returns of over 20 per cent. Most likely is a return just below 9 per cent; the probability of getting only your money back is around 8 per cent.

Roddy Kohn, of Bristol-based independent financial advice firm Kohn Cougar, says: "The great thing about this is the international exposure ... But there's an argument for saying that if you think Japan is going to rocket, then invest directly in Japan."

If you want a protected floor fund, where losses will not go beyond a certain point, useful in the event of a crash, make sure it can withstand the weight of "Black Someday". Some funds, like the Gartmore Safeguard Unit Trust, use a cheaper form of portfolio protection to get more stock market exposure. But while the floor would hold in a gentle downward market drift, with a sudden fall of 30 per cent, it could turn into a trap door.

Other "protected" funds (such as Edinburgh Fund Managers' Safety First) pick stocks and then protect them. This is expensive, and these funds tend not to perform so well. You might even find that the stock-picking element has been curtailed to reduce the expense, so you are no longer getting the fund management skills you think you are buying.

Any product which locks you in for five years, does just that unless you are prepared to pay a penalty to get out. With longer term lock-in products, make sure you don't get locked into a rate at the bottom of an interest rate cycle.

So what is the ideal product to invest in? Financial advisers are reluctant to give blanket approval or condemnation for individual products. Funds referred to time and again, though, are Dublin-based capital-protected PEPs. Being PEPs, they are tax-efficient. Because they invest in a Dublin- based investment company they can be classified as a single-company PEP, even though they are FT-SE-based, allowing for a "diversified" PEP portfolio allowance of pounds 9,000 per year. And, they are simple to understand. HSBC invented them. Legal & General has followed suit, and Commercial Union is apparently planning to

For an independent financial adviser near you, call 0117 971 1177.