Safety for savers, but at a price

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The Independent Online
Government plans to tax profits on gilts have created uncertainty over the future of guaranteed investment products. But those already sold as tax-free will remain tax-free to inves- tors who have bought them.

Safety-conscious investors have been piling into guaranteed bonds in recent weeks. Abbey National's Guaranteed Bond sold out in six days and was withdrawn on Monday, having reached its target of pounds 200m. It was to have been marketed for six weeks.

An Abbey spokeswoman said the bond was sold as tax-free in good faith and investors would receive the guaranteed net returns. Scottish Widows, whose Guaranteed Income Bond (GIB) attracted pounds 323m in March, has already said it would honour its guarantee.

By offering guaranteed capital and income, no charges and tax-free returns well above the going rate at building societies, such offers appeal to traditional building society investors and to equity investors who lost their appetite for risk. Abbey's bond offers a quarterly return of 7 per cent, net of basic tax, or 42 per cent after five years.

Both Scottish Widows and Abbey's bonds - the former offers 7.4 per cent annually net of basic tax - are traditional GIBs invested in cash and something else (gilt options in Scottish Widows case) to ensure high returns.

Despite the guarantees, they are not risk-free. Investors are locked in for five years and cashing in early would nullify the guarantees, leading to a probable loss on the investment. In five years, much can happen. Interest rates are on their way up rather than down in the short term.

In the longer term, a run on sterling, if a Labour government came to power, could force interest rates considerably higher and make the bonds' yields less tempting.

Other guaranteed products are equity-based or have an equity content. Scottish Amicable's PEP guarantees capital and a yield of up to 7.75 per cent a year provided it is held for a five-year period.

General Accident's Guaranteed Distribution Bond, which closed last month, is a halfway house between a GIB and equity product. It guarantees capital and annual income rising to 7.2 per cent in the fifth year, net of basic tax, or 40 per cent over the five years. It also has an equity kicker linked to the FT-SE 100 index. Investors receive the growth in the index (but not dividends) on 20 per cent of their investment.

Legal & General's guaranteed PEP, still open for investment, guarantees capital after five years and gives investors the full growth and income potential of the stock market. Although the upside is not capped, charges are heavier.

Guarantees on equity products provide comfort to investors nervous of the volatility of stock markets, but they have their cost. Investors in the ScotAm PEP would not benefit from a stock market boom, as their returns are fixed. L&G investors pay heavy charges and GA investors receive no dividends.

While many investors are happy to pay the price of safety, Mark Dampier, investment director of Whitechurch Securities, thinks many are piling into guaranteed products at precisely the wrong time. He says investors were hurt by last year's stock market fall and are making emotional rather than rational decisions.

"The time to go into guaranteed products is when the market is at an all-time high," he says.

He also questions the wisdom of locking up money at fixed rates for five years and suggests the premiums offered to do that might not be enough.

For the risk-averse and those who cannot stomach the notion of capital erosion, guaranteed products offer safety at a price. The five-year lock- in period may not pay off, depending on future direction of interest rates and stock markets.

Like other companies, Scottish Widows was intending to launch more guaranteed products this autumn. But now it wants to study the Treasury proposals to see if it can afford to offer such high returns.