Money news, advice and predictions for savers and spenders. This week: sorting out the difference between guaranteed and protected funds.
By Jeremy Gates
When savers look for bonds to beat the minimal interest which many bank and building society accounts will pay on their money, will they always understand the difference between 'guaranteed' and 'protected'?
The difference has become clearer with the admission from Legal & General - a market leader in so-called structured products - that 2,300 investors with £33m invested in two of its 'capital protected' funds might not actually get all their money back when the six year products mature in 2011.
Stemming from the collapse of giant US finance house Lehman Brothers, the incident underlines a disturbing aspects of the crash of 2008; it can be some time after a heavily headlined event before another hapless group of savers realises it could suffer collateral damage.
L&G is warning these investors they might get back only 80% of their original capital if FTSE100 - the index of London's leading shares - is lower in 2011 than it was in 2005, when its plans were sold through financial advisors.
In normal circumstances, money invested in derivatives by Lehmans would have been returned to make up any shortfall in 2011. L&G would have to take legal action to recoup the money, which could easily fail.
Since 1995, L&G has issued 60 structured products - where the payout on maturity is based on the performance of certain indices, usually linked to London's FTSE100 and stock markets around the world.
Marketed through financial advisors (IFAs), they have attracted over £1bn of savers' money. Sixteen plans have matured, 44 are still running, and these are the first two to hit trouble.
L&G spokesman Mike Connolly says: "This product continues to be a good avenue for cautious investors, who face diminishing returns from banks and building societies.
"This sort of product gives investors an exposure to stock markets without being invested in them. We see continuing volatility in stock markets through to 2010, but Lehmans must be seen as un unprecedented event which shouldn't be allowed to undermine the entire sector."
Currently L&G offers - also through IFAs - a Growth Investment Plan Plus 17 (GIPP 17) promising a 150% uplift on the performance of FTSE100 over six years on minimum £500 sums. Closing date is January 17, 2009.
L&G's Mike Connolly says: "These funds are protected, but not guaranteed, which is made clear in sales material.
"We invest in A-rated companies considered to be financially secure, but if these companies don't pay L&G, investors may get back less than they originally put in."
Some structured products guarantee the original capital and repay the money plus an additional sum - subject to certain agreed performance indicators - on maturity. Others pay regular income, without guaranteeing the original sum is repaid when the plan expires.
In all structured products, any promise to repay the original capital is invariably based on the plan running to maturity. Early withdrawals can trigger big losses.
Although L&G is the first mainstream provider of structured products to hit problems, investors in the lesser-known NDFA already face losses from exposure to Lehmans.
Their right to compensation under the Financial Services Compensation Scheme (FSCS) is unclear - because the scheme covers the failure of product providers, rather than other companies involved in the investment.
Danny Cox, head of advice at Bristol-based financial advisors Hargreaves Lansdown, says: "As a rule we don't like structured products, because in many cases, it is difficult for investors to know what they have invested in.
"In this case, it took three months for L&G investors to discover an exposure to Lehman. Structured plans make it difficult to establish underlying assets and underlying protection."
It is highly likely, however, that structured products will remain in demand as savers get such poor returns on their cash.
The possible losses by L&G investors might convince some savers to go for Guaranteed Equity Bonds (GEBs) which promise the original capital is safe under any circumstances.
National Savings & Investments, a leading supplier of structured bonds, has over 100,000 customers invested in GEBs, holding £600m across 16 issues since 2002. No issue is currently on sale.
HS&I spokesperson Gill Stephens says: "Any money invested in NS&I Guaranteed Equity Bonds has the guarantee of absolute security, because it is backed 100% by HM Treasury. Our GEBs are different to those of financial providers who use other counterparties."
Nationwide BS is equally confident. Its sixth issue (with L&G) Capital Guaranteed Multi-Index Equity Bond, which closed just before Christmas, is replaced by the seventh bond on January 5 - and savers in both schemes are fully protected against any turmoil on the markets.
Nationwide's spokeswoman Jennifer Williams says: "Our products are both guaranteed, and effectively underwritten by Santander Bank with guarantees supported by the FSCS.
"Ours are both guaranteed products, with a 100% guarantee of original capital. The two L&G funds which admit problems were protected, which is different."
Once investors are reassured about the security of their money, they also need to look at likely performance - on the assumption that the worst of the recession could be passing by mid-2010.
Protected products should plainly offer a higher return than GEBs - because recent events show they are riskier.
Nationwide's sixth issue GEB, besides committing to repayment of the original capital, also promises a minimum return of 13% (or 2.06% AER per year).
Alternatively, if markets recover by 2015, it will pay 70% of any growth in the value of a basket of three of the world's leading stock market indices - London's FTSE100, DJ EuroSTOXX 50 index, and Japan's Nikkei 225. Minimum investment is £500.
However, the Nationwide plans have no cash-in value until maturity, with no access to money invested for six years. That could be some wait in current conditions.
Danny Cox at Hargreaves Lansdown says: "Better income can usually be earned outside structured products.
"Right now, for example, investors in Invesco Perpetual's Corporate Bond Fund can hope for 7% annual income plus the possibility of an uplift in the value of their holding. Jupiter Income pays 5.1% per year, again with the possibility of an uplift in value as markets recover.
"I see both funds as superior to structural products which have several problems: complexity, and a lack of both transparency and flexibility."
According to the Quarterly Savings Survey from National Savings and Investments (NS&I) covering the period up to November 30, average take-home monthly income has fallen slightly since the summer to £1,329.70, with the amount saved down by just over 2% to £85.34.
Just 47% of adults regularly set aside money each month, says NS&I.
:: INFORMATION: Hargreaves Lansdown (0117 900 9000).
POUNDNOTES
:: Fixed rate mortgages account for 69% of the home loans market, against 51% a year ago, says Michelle Slade at Moneyfacts.co.uk - and that's costing many borrowers dear because the average two year fix has fallen by only 0.71% since October 1.
Slade says lenders are steadily widening the gap between the cost of the money - the swap rate - and the cost to borrowers. By refusing to reintroduce cheaper tracker mortgages, lenders effectively leave borrowers little alternative to a more expensive fix.
Slade says: "Today the average gap between the average two year fixed and tracker mortgages stands at 1.16%, compared to just 0.14% this time last year."
However, Abbey claims cuts to its fixes over two, three and five years by up to 0.6% make them market-leading to borrowers with LTVs (Loan to Value) up to 85%. Two and three year fixes start at 4.64%, with five years deals from 4.94%.
:: Since Dec 1, it's been carnage for savers, says Louise Bond at price comparison service uSwitch.com, with 76 providers cutting savings rates by as much as 4% across more than 150 products.
Heaviest cutters so far have been on Alliance & Leicester's Save and Protect regular deposit account - cut by up to 4% on new applications, Cahoot's savings account (cut twice this month by total 2.99%) and Liverpool Victoria's Easy Access cash ISA (two reductions totalling 3%).
Louise Bond at uSwitch says: "December has been a particularly bad time for savers, with what feels like the fallout of three base rate decreases."
Further uSwitch information: 0800 093 0607 and www.uSwitch,com.
:: Around 10% of adults - that's about 4.5m - still haven't settled credit card debts from Christmas 2007, says new research from MoneyExpert.com which warns that £1000 of debt has already cost £169 in interest charges over the past year.
The financial hangover from last year is worse for the 25-34 age group.
Sean Gardner of MoneyExpert says: "It really is time for card users to restructure repayments and start clearing their debts. Options for consumers looking to switch large balances from one card to another are more limited as requirements become stricter."
:: Savers shouldn't take their punishment lying down, says Andrew Hagger at www.moneynet.co.uk. Anybody with £50,000 in an account earning 0.3% would now earn a derisory £10 per month, before tax.
The same sum in an AA Internet saver account currently paying 4.53% would earn £151 per month (net of 20% tax), so it's well worth shopping around.
Andrew Hagger says: "With rates predicted to tumble further in early-2009, it is definitely time to lock into a fix before they are slashed again."
