Personal finance: Only the risk is certain

Can a bond be guaranteed?
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WHEN IS a guaranteed investment product not guaranteed at all? When it's a guaranteed high income bond. This month, the Treasury announced a crackdown on certain high-income bonds, amid warnings that many investors may not understand that their standing capital is at risk.

Investors have been buying up to pounds 400m worth of high income bonds annually. After tax, the most competitive bonds pay up to 10 per cent income annually, compared to the 5 per cent or so yearly net interest rate available from the best savings accounts.

The comparison isn't strictly fair. While savers who put money into building society accounts can be certain that their capital is risk-free, high income bond investors risk losing some of their money if stock markets decline.

Scottish Mutual's recent high income bond offering is typical. It promised to pay 8 per cent income a year, after tax, for five years to its holders. At the end of this period, investors get their original capital back in full, as long as the FTSE 100 index and the Swiss stock market index, the SMI, have not fallen by more than 15 per cent.

Another insurer, Eurolife, has been offering even better rates. Its last high income bond issue pays 10 per cent a year after tax. But savers will lose some of their capital at the end of the five-year term of the bond is any of the three indices - the FTSE 100, the SMI and the US S&P 500 - has fallen at all.

Insurers can offer these incomes by underwriting their bonds with stock market derivatives - essentially, bets on share price movements. The Treasury believes such risk is unacceptable, hence its insistence this month that no future sales of high income bonds written in this way will be allowed.

The government's position is understandable. Nevertheless, the Treasury ban puts income-seekers in a pickle. As David Wooton, managing director of Eurolife, says: "There is a demand for high income bonds with an element of risk to capital."

Another high income bond provider, insurer Scottish Life, may have the solution. It has just issued an Income Bonus Bond paying 9 per cent income a year, after tax, and is linked to the FTSE 100 and the SMI. However, Scottish Life's bond will return capital in full as long as the two indices average 6 per cent growth a year over the bond's five year term. The bond isn't risk-free but the emphasis on an average growth rate enables it to circumvent the Treasury veto.

Philip Martin, business development manager of Scottish Life, believes the new bond is the way forward. "Our bond is very transparent - we've constructed it to fully reflect market growth," he says.

Other high income bond providers are already reassessing their product ranges. Christine McAllister at Scottish Mutual, says: "Our product design team are working on this." Similarly, Eurolife's David Wooton says: "We're now designing new products which won't give us a problem."

Whatever insurers come up with, it is unlikely that high-income bonds will pay the sort of income they've offered in the past. At 9 per cent annually, the new Scottish Life bond, for example, is a full percentage point a year less generous than other products launched recently.