Guaranteed bond yields poor return

SAVERS who invested up to pounds 60m in an insurance company's guaranteed stock market bond have been caught out by the recent share index downturn. Many would have done better if they had kept their money in a building society account.

More than 5,000 investors placed their cash in Scottish Provident's three-year Capital Guarantee Bond, launched in June 1991.

Those whose bonds are maturing now are finding that pounds 10,000 of their capital in the bond has grown to pounds 11,727. A high-interest building society account would have returned about pounds 11,800.

Mark Dear, a partner in Holden Meehan, a firm of financial advisers in London, said: 'These figures are awful. If you want an absolute guarantee you should be looking at a building society Tessa or National Savings account to put your money in, not the stock market.

'This was a clever marketing effort. It seems to have attracted a lot of money, but it doesn't appear to have worked that well.'

Guaranteed equity bonds place a proportion of savers' money in funds tracking the movement of the FT-SE 100 share index, or invest directly in the FT-SE shares. The remainder is used to buy stock market options to underpin the money-back guarantee.

As interest rates have fallen, however, the price of the option used to hedge against any potential market fall has increased.

This means that more of the original investment has to be used to deliver the guarantee, cutting the main fund's exposure to any potential gains.

In addition, these funds only track the FT-SE 100's rise or fall, not the dividends paid by the top 100 companies themselves. This further erodes any potential final payout.

John Hay, product marketing manager at Scottish Provident, said: 'The product was a good one at the time. Obviously, there is a risk of a downside, as with any equity-based investment.

'But any investors in the bond were also being guaranteed their original money back if the stock market fell over that period.

'This is what they got. It is important to remember that they did not actually lose money. In fact, in each case, investors made gains on their savings.'

Scottish Provident launched two other issues of the same three-year bond. The first, maturing in February 1993, would have delivered pounds 12,376 on investments of pounds 10,000, compared with at least pounds 12,500 from a building society account.

Only the slice issued in October 1990 would have beaten a building society. It would have delivered pounds 13,489, compared with pounds 12,316 in a building society.

The difference in returns was due to sudden changes in investment conditions, catching investors in the first and third tranches of the bond.

Mr Dear said: 'If you want to invest in the stock market, three years is not a long enough period to do it because your money is likely to be affected by any short-term movement. We recommend a minimum of five years.'

Most companies offering similar bonds, such as Scottish Amicable's Capital Guarantee Bond in early 1993, have done so on a five-year basis. ScotAm's bond also includes dividend gains as part of its growth.

Hypo Foreign & Colonial has an open-ended fund, which investors can join and leave at any time. Each quarter, the fund locks into gains made by the FT-SE 100 index. But the cost of guaranteeing against losses means that only a relatively small amount of investors' money is exposed to the FT-SE 100 index.

Save & Prosper has issued six tranches of its Guaranteed Stock Market Bond in the past 18 months. The bonds lock into gains based on 20 per cent of market growth. Four out of the six have done so - most recently the mid-July issue, which locked its gains in January this year.