The bond that time forgot

Investors who want reassurance as well as returns on their cash might take a look at distribution and guaranteed income products
In the early 1990s distribution bonds were a popular investment.

The insurance firm Sun Life, in particular, was raking in the cash with its own pounds 3bn bond fund, and other life insurance companies were rushing to launch their own me-too products. Since then, however, distribution bonds have largely disappeared from view.

Inevitably part of that earlier popularity was simply because they were heavily pushed by the life insurers, and because more tax-efficient personal equity plans (PEPs) had not reached their current popularity.

But part of the explanation was also that, as relatively conservative stock market-based investments, they appealed during a period when memories of the 1987 stock market crash were still fresh in investors' minds and the stock market remained volatile.

Keith Middleton, a marketing manager at Sun Life, explains: "The original concept was to mirror a building society type investment, trying to protect the capital, but paying out an income as well.

"The basic idea of distribution bonds is that, as far as possible, capital value should be maintained."

Distribution bonds pay an income, normally half-yearly, which is net of basic-rate tax. Higher-rate taxpayers can postpone their additional tax liability for up to 20 years, so long as this income and any other withdrawals are less than 5 per cent a year. This can be useful for people who plan to drop tax bands, say when they retire, because that way the tax slate is wiped clean. Even with this potential attraction, however, distribution bonds are significantly less tax-efficient than PEPs, where all profits are tax-free.

A distribution bond will put your money into a mixture of investments such as shares and gilts. The mixture of holdings in each company's bond may be very different, and it is this mixture that will determine the bond's performance. Sun Life says pounds 10,000 invested in its distribution bond on 1 December 1990 would have grown to pounds 17,174 five years later. The comparative figure for a higher-rate building society account is pounds 12,448.

It was the Sun Life bond's heavy weighting towards gilts which appealed to safety-conscious investors in the turbulent early 1990s.

"Now the stock market's doing well, of course, it's worked against Sun Life," says Stephen Ingledew of Frizzell Life & Financial Planning, a firm of independent advisers. "But there are distribution bonds on the market that have a higher holding in shares.

"On the other hand, there are companies like Allied Dunbar that have had a higher proportion in property, and property has not been a good investment in recent years."

The lesson is to be very clear just what investment mix each distribution bond adopts before deciding between them.

In the case of Sun Life's bond, both the biggest and the longest-running on the market, the minimum investment is pounds 5,000, rising to pounds 12,000 if monthly income withdrawals are required.

The bond carries an initial charge of 5 per cent and an annual management charge of 1 per cent. It is worth remembering that there is an exit charge of up to 5 per cent if you cash in the bond within five years.

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