Ask Annie: How safe will my cash be in exotic exchange-traded funds?

Q. I am attracted to exchange-traded funds by their low cost and flexibility, but am cautious given the underperformance of other investment products such as with-profits funds and split-capital trusts.

Are there are any specific drawbacks in ETFs, other than normal stock market risk? Are the funds covered by the Financial Services Compensation Scheme? SC, Bristol

A. ETFs are a hybrid product. Like shares and investment trusts, they can be bought and sold on a stock exchange. However, they work more like a unit trust tracker fund, with their value, up or down, being tied to the fluctuations of a particular stock market index rather than the share prices of a company or group of companies.

While the first ETFs to be marketed tracked indices in developed econo- mies, including the UK and US, they now follow just about anything, from emerging markets through to various specialist sectors, precious metals and other commodities.

There are hundreds of ETFs to choose from, including Barclays' iShares, Deutsche Börse's x-trackers and Invesco PowerShares. New funds are being launched all the time.

Like trackers, ETF fees are low because the funds simply follow the moves in an index and don't require any input from a manager. There is no stamp duty to pay when buying an ETF and they can be held in an individual savings account (ISA), where growth is free of tax. You will need to use a stockbroker to buy or sell the funds, with charges typically ranging from £10 to £15 for a single trade.

Mark Dampier of independent financial adviser Hargreaves Lansdown says: "ETFs are 'passive investments' like trackers, so there is nothing inherently dangerous about them. They are as safe as any stock market – there are no catches."

Any dangers, he adds, would arise with the indices in which you are invested. For example, markets such as the Chinese FTSE/Xinhua 25 or India's Sensex can be high risk.

"Investors often don't understand exactly what their exposure is, because they don't realise the proportion that a particular share gives to various indices," says Mr Dampier. "For instance, ICICI, India's second-biggest lender, which has been hit by fallout from the US sub-prime crisis, and Reliance Industries, India's largest petrochemical firm, together account for about a quarter of the weight of the Sensex."

"So if these companies fall on hard times, they can bring the index down by more than an unwary investor might realise."

A spokesman for the Financial Services Compensation Scheme says you would not be covered for any loss you make on an ETF investment. However, if you think you have been mis-sold an ETF by a financial adviser or broker – for example, you may have been told the performance would be guaranteed – then you could take a case to the Financial Ombudsman, who can order compensation.

Q. I received some money over a year ago direct into my bank from the Pensions Annuity Friendly Society. The payment has been worrying me as I have no idea where the money has come from and I can't find any trace of this society. TJ, Basingstoke

A. Members of the mutual Pensions Annuity Friendly Society, the UK's first writer of impaired and enhanced annuities, voted for demutualisation and a management buyout in 2005, and as a result received a minimum windfall of £500. The business was rebranded Partnership Assurance, and you can check to see the reasons for your payment by calling 020 7618 2800.

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