Your safety net under the equity tightrope

Clare Francis examines the value of plans that protect your investments from falling markets

Mellon Global Investments, which counts Newton Investment Man- agement among its subsid- iaries, will become the latest member of the protection club when it launches the Protected Newton Higher Income Plan tomorrow.

Investment products that safeguard investors' capital have become increasingly popular in the wake of three years of falling stock markets. As a result, more and more providers are jumping on the bandwagon. Traditionally, the plans have been viewed with some suspicion because investors have to pay a price for protection somewhere else along the line.

The returns on such products are usually linked to a market index, but you tend not to receive the full extent of any gains on that index. For example, Standard Life has a five-year protected bond that is linked to the FTSE but investors only get 52 per cent of any increases in the FTSE over that term. Other plans may appear more attractive, but when you look more closely you may find, say, that your capital is only protected as long as the FTSE doesn't fall below a certain level.

"There's a downside with all of them," says Nikki Foster at independent financial adviser (IFA) Chase de Vere. "You have to make sure that the client is happy to pay the price for that protection. And at the moment, most are."

Most investors are reluctant to invest any more money in equities until there are signs that the markets are stabilising. So it's not surprising that products guaranteeing to protect an investor's capital are proving an attractive option.

Close Management's protected UK Escalator 100, for example, has produced positive returns since its launch in 1996 and is up 36.6 per cent, while the FTSE 100 has fallen 3.5 per cent during that period. So, depending on the fund, you can make positive returns even in a bear market.

But with so many protected plans available, it's important not just to go for the first one you find because some are far better than others.

"You've got to make sure you choose one that is linked to something which complements your existing portfolio," says Ms Foster. "It's still important to look at the overall asset allocation within your portfolio even if you're going for a protected product."

Among the plans that are popular with IFAs is the HSBC Capital Protected Growth Plan. This six-year product offers investors 100 per cent of the growth of the FTSE 100 as well as capital protection. But if the FTSE rises 18 per cent or more over two years, the plan will close and investors will receive their capital back plus 18 per cent growth. The same applies if, over four years, the FTSE goes up by 36 per cent.

Patrick Connolly, associate director at IFA Chartwell Investment Management, points out that this is where the downside lies: "The price you're paying is that if after two years the FTSE has gone up 25 or 30 per cent, you'd still only get 18 per cent back."

Another attractive option is the Keydata Dynamic Growth Plan 3, a five-year product linked to the FTSE 100. Investors will receive five times the rise in the index subject to a growth cap of 60 per cent. So if the FTSE rises by 10 per cent over five years, investors will get 50 per cent growth.

However, if the FTSE falls 50 per cent or more, the capital protection ceases to apply. This is quite an aggressive plan and there is some risk attached, but Chartwell believes it could be an ideal product for investors nursing heavy losses on their portfolios. It offers an accelerated way of recouping some of their losses without putting the capital at undue risk.

The new Protected Newton Higher Income Plan is slightly different in that it is linked to the performance of the Newton Higher Income Fund rather than an index. But in order to give protection, some of your investment will be held in cash, which Mr Connolly says is the problem with this product.

"The price you're paying for the guarantee is that you don't know what exposure you're getting to the fund," he says. "And it may be that in order to meet the guarantee, you have to hold more in cash, which will obviously affect your return."