While guaranteed investments have always had a role to play in a balanced, diversified portfolio, they are particularly attractive in the current climate of low interest rates and stockmarket vola
While guaranteed investments have always had a role to play in a balanced, diversified portfolio, they are particularly attractive in the current climate of low interest rates and stockmarket volatility.
Technically they are termed ?structured products? and they are designed for Investors who wish to have exposure to rising equity markets with a guarantee that they will get their capital back.
The returns offered by guaranteed products are variable, but are often dependent on the performance of an index like the FTSE 100, or a few indices from different parts of the world (eg, UK, Europe, US and Japan).
There are various types on the market, and although at a glance they can appear similar, some are more risky than others and you may be better advised to leave your money in the bank. It depends on how they work and the guarantees offered.
Often the products offering the most exceptional returns carry additional risk (which can be buried in the small print), or the conditions needed to produce the returns are unlikely to happen.
The type and level of capital protection
There are funds available which do offer a 100% capital guarantee, but others offer less than this. There are two types of protection:
Hard protection ? This gives you a fixed level of protection (which can be 100%, depending on the fund), even in falling markets. So, with a 100% capital guarantee, you will receive all your original investment back even if one or all the indices have dropped over the investment term.
Soft protection ? You do not have a fixed level of protection and the return of your capital is dependent on the performance of the underlying indices. There will be a pre-defined barrier which when breached will trigger capital loss conditions.
For example, an investment may offer return of your capital provided the underlying index does not fall by 50% or more from its starting level at any time during the term. If it then does not recover to its starting point by maturity, the capital will be reduced by 1% for each 1% the index has fallen. So if the index dropped by 50% from the start date, and was still down 40% at the end of the term, investors would only receive 60% of their capital back.
This can affect returns as well as the original capital. Let?s say, for example, that the investment is a five year term and in the first two years the conditions to generate returns have been met. Then in the third year the index falls by 50%. The investment could then continue to the end of the fifth year but no returns at all will be given and you may receive back less than your original capital depending on the extent the index has recovered by maturity.
You must read the small print and understand exactly how the investment works and what risk you are exposing your capital too. As we are now too well aware, share prices can fall drastically. If the main reason to use a guaranteed investment is to protect your capital against such falls, there seems little point in using a product where a similar fall could result in capital loss ? you may have been better off leaving your money in the bank.
Ring fencing
If the investment is based on performance of more than one index, then make sure that each is ?ring fenced? from underperformance from the others. This way, if one of the indices produces a negative performance, you will still receive a return based on the performance of the others. Even if only one outperforms, you should still receive a return.
If all the underlying indices underperform you will still receive all your capital back, provided you have a hard protection 100% capital guarantee.
Fixed terms
Most guaranteed investments are for a fixed term, with a strike date and maturity date, usually between five and six years.
You need to be confident that you will not need your capital over the term. You should nonetheless establish that if something unexpected happens and you need to withdraw some or all of the money, you are able to do so. This would affect the returns and the guarantee, since it is dependent on the investment being held full term, but you would at least have the option.
The guarantor
A structured product will have a guarantor, usually a bank. The capital guarantee is dependent on this financial institution meeting its obligations ? if it does not, the maturity proceeds may be severely or totally impaired. It is therefore important to identity the guarantor and consider whether the risk is acceptable. You would be more comfortable with a long established, reputable bank (though as we have seen, even this cannot guarantee it will not fail).
Since the risks involved with some guaranteed products are usually played down by the promoter, you need to read the small print very carefully. An experienced financial adviser like Blevins Franks will help you select the most appropriate investment for your needs and risk tolerance and explain exactly how the product works.
By Bill Blevins, Managaing Director, Blevins Franks
23rd July 2009
