Investment Adviser Worldwide Financial Planning Join Date Aug 2008 Posts 160

Why ‘guaranteed’ investments may not be totally safe

You will see a plethora of guaranteed investment products in the market today, but be very careful what you are buying.

All too often we are left holding the baby because of small print, and too many investors are easily led into capital protected or guaranteed products without realising what they are getting into. Here is a breakdown of one that appeared ‘nice’ at the outset, but in reality offers poor value, and there is — as with most if not all of these investment schemes — the potential to lose all your capital.

With all the negative euphoria in the world today it is easy to see why there are a range of structured or guaranteed products being released.

I cannot stand them, and I am confident that most people cannot see beyond their headline attractions and understand the risks involved.

So, if you have seen any of the arrangements in the shop windows of banks (normal hiding place for them) prepare to be enlightened. I will use Cater Allens recent offering as an example. Cater Allen is part of the Abbey group.

I describe these capital protected or guaranteed plans as a bit like wetting a piece of cotton and pushing it into the air. A fruitless task with no real benefit at the end, but it passes the time when nothing else is happening.

Cater Allens Selected UK Banking Plan2 offers 11% return in any of the first four years if the value of each of four banking stocks is higher than the initial price they are bought at. Year two would be 22% and so on.

This might seem a great idea at first. As investment adviser I think its brutal. The plan is sold on the basis that banking shares have taken a hiding and are cheap.

That statement was also mentioned five months ago. You now know anything that can get cheap can get much cheaper. These options, of maturing in each year only if all four stocks are higher than their initial strike price, represent poor value.

If the four stocks do rise and they soar, you will get a maximum of 11% in the first year. If they all fly except one, you wont get a penny. All four have to rise.

This is an inverse of modern portfolio theory. Consider that the four stocks are Lloyds, Barclays, RBS and HBOS, and you may now have taken your eye off that headline rate of 11%. In a normal spread of the four stocks you would get a spread of their performance.

In this instance 100% per year for three stocks, and zero or less on another, would mean that you wouldnt get a penny in each year until the plan matures.

Any plan that offers an early maturity option — basically a short term kick-out option — should be avoided at all costs.

At maturity, the plan will give you an average of the value of each of the four banking stocks, but this average is over the last two years, which will clearly dilute the upside of the returns. Averaging should be just the last year at most.

Consider that you will be giving up a large proportion of your returns as they do not pay dividends in this type of arrangement.

Lloyds has been averaging c35p per share dividend over the last seven years. Within a structured plan these are lost. Is it really worth that risk?

Speaking of which, whats the guarantee really worth?

The guarantee is provided by a counterparty. In this instance that is Abbey National Treasury Services (ANTS).

How many customers know what that really means to them? Do they know what risk ANTS carry?

What is the real potential for loss here? Do they know that if ANTS goes bust the customer will get nothing? You see, its down to the FSCS rules, which state that the customer is not the investor, and Cater Allen, as the investor, is caught under the large company rule, so FSCS doesnt come into play and you have no protection at all.

The documents explain that it is ‘unlikely’ that ANTS will fail to repay the loan at the end of the term. Mmmm. Why is it unlikely? We are never caught by likely events.

This is not to suggest that ANTS is at particular risk, just that we don’t know what the risk is, and it can be very hard to find out.

We therefore have to think and look very closely, not just at the fine print, but what that fine print actually means and how it can affect you.

There is an abundance of these arrangements around, and they will continue to be offered as a simple protected investment to the upsides of the stock market. As you can see they are not.