Roll up, roll up: it's the amazing low-risk way to walk the stock market high wire

Guaranteed equity bonds are pulling in the punters. But, as Jenne Mannion finds, they offer security at a price
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The Independent Online

Getting the best of both worlds is always a tempting proposition. So if a financial product promises "the potential for high rewards at low risk", it's no surprise that a wave of money follows.

Getting the best of both worlds is always a tempting proposition. So if a financial product promises "the potential for high rewards at low risk", it's no surprise that a wave of money follows.

This pitch lies behind the recent surge in sales of "capital protected" (or "structured") products. Pop into your high-street bank or building society and you'll probably find a leaflet advertising one in the shape of a guaranteed equity bond (GEB).

Tie your money up for between three and six years, and you'll get either a share in the rise of a stock market index or, if it slumps, your cash back - guaranteed.

Such offers have proved tempting to investors, particularly those who have become disillusioned with the stock market after the sharp fall between 2000 and 2003 and the slow recovery since then.

National Savings & Investments (NS&I), the savings giant backed by the Treasury, has sold more than £800m worth of GEBs in the past three years.

Eager not to miss out, rivals including Nationwide building society, the Post Office, Legal & General and Abbey have now launched similar products.

Here's how they work: rather than plough your money directly into the stock market itself, the return on your money depends instead on the overall performance of a particular index. Say you put £1,000 into a guaranteed equity bond offering 50 per cent of the growth in the FTSE 100 over five years. If the index were to rise by 30 per cent, you would benefit from just half of this growth. So, on £1,000, you would earn 15 per cent, or £150.

This might not seem like such a great return over five years, but it's the price you pay for the money-back guarantee.

If the same index were to fall 20 per cent, your original cash sum would be returned to you, although inflation would have eaten away at its value.

This example shows only the most basic type of plan. Other capital-protected products offer a guaranteed minimum return of, say, 25 per cent, or the full rise in the index, whichever is the greater. (So you get your money back with interest, even if the markets fall.) Alternatively, high-risk plans are available linked to overseas indices; your capital is guaranteed only if the indices don't fall by more than, say, 40 per cent.

Despite the safety nets that such products offer, many independent financial advisers (IFAs) are sceptical about them.

"The guarantees that give you peace of mind come at a price," warns Patrick Connolly of IFA John Scott & Partners.

The companies behind structured products use fiendishly complex financial instruments such as derivatives to make sure they can meet their promises to you, says Mr Connolly. This is expensive, and the cost is ultimately paid by the investor in the form of lower returns.

If you then take into account taxes on gains, inflation and the risk attached to investing in the stock markets, guaranteed investments start to lose some of their shine.

"Investors could receive better returns by putting their money in a five-year fixed-rate deposit account," says Ben Willis of IFA Chartwell.

Savers can earn around 5.3 per cent interest a year in the best accounts currently available, he says. For basic-rate taxpayers, the rate of return would be 4.24 per cent after tax.

"This alone," Mr Willis adds, "would exceed the minimum return on any bond that promised to pay at least 25 per cent at the end of a six-year period - equivalent to 3.8 per cent per annum." You can also access your capital a year earlier, too.

Structured products include penalties if you want to take your cash early. Another downside - a critical one for a stock market-linked product - is that you gain no benefit from the dividends that many companies pay their shareholders.

This latter concern has prompted a warning from Mr Connolly regarding the latest GEB from NS&I. This offers 125 per cent of any growth in the FTSE 100 index over five years - or your money back if markets crumble.

But Mr Connolly says investors will benefit only if markets "perform exceptionally well or exceptionally poorly".

For a basic-rate taxpayer, only if the FTSE 100 were to fall or rise by more than 38 per cent would the product beat a simple mix of 50 per cent shares and 50 per cent cash, he says.

"The NS&I products are hugely popular but people do not seem to be aware that there are many shortcomings, and even cautious investors could be better placed investing elsewhere," Mr Connolly concludes.

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