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Market guarantees set to cost more

Investment products that promise returns are falling foul of the stock market turmoil, says Clifford German
ROYAL & SunAlliance last week followed Legal & General in withdrawing from sale products which offer investors a money-back guarantee on unit- linked investments if markets actually fall.

Existing investors are unaffected, but the decision to withdraw the products rather than put up the initial charge for new investors reflects the sharply rising cost of providing the guarantee by taking out options in the derivatives market.

R&SA's divisional manager for marketing and sales, Keith Luckhoo, said that stock market volatility over recent months has caused the actual cost of the optional capital protection guarantee on its Portfolio Growth PEP to increase from 3 per cent to around 12 per cent. The option, for which investors paid the extra 3 per cent upfront, has now been withdrawn, although the PEP remains on offer without the guarantee.

"The cost has now risen to a level where we feel that if passed on, it no longer offers investors good value for money," Mr Luckhoo said.

Legal & General withdrew its own Guaranteed Stock Market Investment Plan and the associated PEP investment in June after the effective cost of providing the guaranteed return of capital after five years rose from the budgeted 4 per cent to around 10 per cent of the total investment.

The company was forced to choose between repricing the product with a higher initial charge, offering new investors a less attractive package, or continuing to subsidise the guarantee out of the annual management charge.

Legal & General also closed its Growth and Protection PEP linked to four European stock market indices in July. That offered investors geared gains of up to 100 per cent over 61/2 years as well as a guaranteed return of capital at the end of the period.

L&G is currently deciding whether to issue a new tranche on terms reflecting the higher cost of offering the guarantee.

Stock market bonds offered by life assurance companies which combine exposure to the stock market with some form of guarantee are also affected by the rising cost of providing the guarantee, but a number of these products are still available.

Natwest's Guaranteed Capital Bond, for example, currently offers two options, one of which gives a maximum 60 per cent return if the FTSE rises that far over 51/2 years, the other returns up to 30 per cent if the index rises that much over 31/2 years, but a full return of capital is guaranteed in both cases, even if the market falls.

GE Financial currently offers a capital guaranteed product with 75 per cent maximum return over 51/2 years if the Eurotop index performs strongly, while Bristol & West's new 20th issue of its Guaranteed Equity Bond launched this week pays up to 100 per cent of the average rise in the FTSE, the S&P500 and the Nikkei over the next five years, and money back if they fall.

These "defined return" products tend to be marketed in limited tranches; the cost of the guarantee is included in the terms of the offer and the terms can be varied in the light of market conditions.

They look attractive now that the market has fallen and established a new lower base. Subsequent offers will almost certainly be issued with less attractive returns, reflecting the higher cost of providing the guarantees.

The rising cost of providing guarantees could also affect the Barclays B2 accounts which opened for business in May.

Over 90 per cent of the account-holders so far opted for a guaranteed 100 per cent return of capital in return for which 14 per cent of their money is set aside to buy the guarantee, while the remaining 86 per cent is invested in the stock market. The cost of the guarantee is reviewed quarterly and could could go up at the end of this month,

Meanwhile, returns on guaranteed income bonds have also started to come down sharply, reflecting the cost of the guarantee. GE Financial, for example, has cut the return on its pounds 10,000 one-year guaranteed investment bond from 6 per cent to 5.64 per cent, and the return on its five-year GIB from 5.1 per cent to 4.9 per cent this week.

Pinnacle has cut its five-year bond from 6.5 per cent to 5.85 per cent; Hambros has cut its one-year bond from 5.75 per cent to 5.29 per cent and its three-year bond from 5.50 per cent to 5.31 per cent.

Returns on some other fixed-rate products are also trending down, although this has more to do with the rate at which money can be re-invested in the money market.

The Woolwich pulled its one-year fixed rate bond offering 8 per cent on a minimum of pounds 500 and replaced it with a similar issue paying 7.4 per cent; C&G has withdrawn its one-year bond paying 7.5 per cent fixed on sums of pounds 1,000 and has not yet introduced a replacement.