How 'guaranteed' are equity bonds?

Posted on: 16 June 2009 by Gareth Hargreaves

They promise the seemingly impossible - if the stock market goes up, investors will enjoy the gains, but if it goes down, investors' capital will be safe. They simply can't lose.

That enticing offer is at the heart of guaranteed equity bonds. But Gebs and other 'structured products' as they are known in the financial world have been dogged by scandal and failure.

One of the biggest players in the Geb market, Keydata Investment Services, was declared insolvent last week after the Financial Services Authority decided that 24 tranches of bonds it had issued as qualifying Isa investments did not meet the conditions for tax-free Isa status.

The cost of correcting the blunder was too great for the company and administrator Pricewaterhouse-Coopers moved in last Monday. The hope is that a new buyer - and many have shown interest - will step in as early as this week and that investors will experience no more than a little disruption.

But on Monday, 14th June, neither the FSA nor PwC was able to give all Keydata investors an absolute assurance that their money was safe. Most of the 85,000 savers have plans where Keydata was the administrator only. These plans were sold under numerous brands, including HSBC, Royal Bank of Scotland and Derbyshire and Leeds building societies. The risk posed to these savers is thought to be remote. Their money is almost certainly ring-fenced and secure.

However, there is less clarity about the dozens of bonds provided by Keydata itself. The FSA maintains it is 'too early to say' whether there will be losses, but admits this situation is 'not ideal'. Even if investors' capital is safe, questions persist about ongoing income payments to investors - they were suspended last week but resumed on Friday - and about the tax status of bonds that investors had believed were qualifying Isas.

“Investors with Keydata are likely to experience stress, inconvenience and a lack of access to information, but hopefully that will be the worst of it - their money should be safe,” says Nick Sketch, senior investment director at wealth manager Rensburg Sheppards in Leeds. He is a fan of Gebs, provided they are not susceptible to some major risks.

The first risk, he says, is in the bond design. Some are highly complex and pass on losses if, for instance, the underlying stock market falls below a certain point. These losses can be triggered quickly, giving rise to the name 'precipice bonds'.

The second risk is that the bond's underlying assets are held with a bank or other institution that is unstable. Gebs linked to failed investment bank Lehman Brothers lost money in this way, as did investments backed by struggling American insurer AIG. At the lowest end of the risk spectrum, some Gebs are underwritten by the Government when they are offered by National Savings & Investments. Another risk has emerged in the case of Keydata, where the administrator of Gebs runs into trouble.

“Structured products appear simple, but in reality are complex,” says Sketch. “That combination is usually a cause for worry where investments are concerned, but it does not ultimately mean that all structured products are bad.”

Jason Walker of adviser AWD Chase de Vere in Bath, Somerset, agrees: “The pitfalls are their complexity, but Gebs can work for many investors by offering protection and security.”

But Nic Round of investment manager Murray Round in Shrewsbury, Shropshire, is opposed to these investments in almost all their forms. “They are not transparent, they are designed to make money for the provider first and foremost and they use investors' fear as a marketing tool,” he says. “Why would investors buy these plans? Why do advisers recommend them? Are they really that good?”

Saran Allott-Davey of financial planner Heron House in Newport, South Wales, is also a critic. “They are inevitably sold to investors at the worst possible time, which is when stock markets have already fallen. When markets are roaring upwards, these deals miraculously disappear,” she says.

Keydata Collapses & The Big Banks Face Angry Investors Again

HSBC, which claims to check its partner companies rigorously, was promoting a 'structured' investment managed by Keydata Investment Services last week - on the day the firm was forced into administration. HSBC declined to comment.

But a bank running into trouble over guaranteed equity bonds is not uncommon. Barclays and Coutts, the upmarket bank owned by Royal Bank of Scotland, face litigation from wealthy clients facing losses on structured products with exposure either to bust bank Lehman Brothers or American insurer AIG. And in 2003, Lloyds TSB had to pay more than £100m compensation to risk-averse customers it deceived into investing in high-risk, structured products offered by its Scottish Widows arm.

Simpler structured products with more valuable guarantees offer lower returns. Government backed National Savings & Investments offers several guaranteed equity bonds every year. They promise to pay the increase in the FTSE 100 over five years, tax-free.

Even if the index falls, the investor gets the money back, but without interest. This is less generous than many Gebs, which can offer more than 100% of the market's growth or a minimum positive return. But the Government-backed promise is more valuable. 

Investors with NS&I Gebs maturing soon are unlikely to see a profit because the Footsie, which closed at 4,441.95, is down from about 4,600 five years ago.

Risk-shy saver Michael Barnet, 48, has a five-year NS&I Geb maturing in November. “I will probably get nothing but my original money,” says Michael, who works with Age Concern, “but there's still a chance of a return. When it matures I'll be tempted to invest in another Geb from NS&I.”

But Michael, from Welwyn Garden City, Hertfordshire, insists: “I only save where I know my capital is safe.”

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