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Equity-linked bonds bring fresh misery for investors

Katherine Griffiths
Thursday 20 June 2002 00:00 BST
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The Financial services industry is heading for another showdown with angry investors as a host of bonds invested in the stock market maturing this year are unlikely to return the capital originally invested.

Equity-linked bonds are the latest product to disappoint, having been sold in many cases as low-risk investments. Their poor performance comes after thousands of investors have seen their capital in split capital investment trusts disappear in recent months, even though those products were also sold as low risk.

Bonds that are invested in shares have performed well in the past few years, returning income of about 10 per cent as well as investors' original capital.

But experts believe that bonds maturing this year will be the first of their class not to hand back a substantial proportion of people's capital. The gloomy pattern has already begun. A three-year bond offered by the small life assurer Eurolife, saw investors loose 18 per cent of their capital when it matured in April.

Patrick Connolly, associate director of financial advisers Chartwell, said this was "the tip of the iceberg".

"There are many bonds maturing over the next 12 months where investors stand to loose a significant part of their capital. In many cases investors are relying on stock market rises of between 30 and 67 per cent in order to return their capital," Mr Connolly said. Specific examples of how much various market indices must rise to protect capital invested in bonds maturing in the next year are given in the table.

Equity-linked bonds promise to pay a certain level of income for the life of the product but do not guarantee capital will be returned in adverse market conditions. But some advisers feel investors will not properly appreciate that the capital is not guaranteed. Mr Connolly said: "There are some similarities with split capital funds – neither were marketed as high risk and now both are blowing up in people's faces."

But investors will probably not have been aware that companies providing equity-linked bonds in recent years have made their investment strategy increasingly risky. They did this to maintain the high level of income offered on products at a time when interest rates and inflation were falling.

Maintaining high headline returns tend to attract customers, even if the company is taking more risks with the underlying capital to achieve that rate.

Common tactics companies have employed in the past few years have included linking bonds to Nasdaq, the US exchange focused on technology stocks, rather than the FTSE 100. They have also increased gearing on bonds, which boosts any upside but also means an escalation of losses if the chosen index falls. Another move has been to quote annual returns gross of tax, rather than the usual position of quoting the return net of tax.

Mr Connolly said: "There is no justification for increasing the risks on these products and not clearly spelling out these increased risks in literature. It does appear that in a number of cases the risks were not explained as well as they should have been." Chartwell has produced a review of equity-linked bonds that are about to mature, and full details will be published in The Independent's Your Money section on Saturday.

But he also blamed investors for jumping on products with high headline rates rather than something that was more cautiously invested but offered a lower annual return.

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