Capital guarantees either displace investment risks or limit potential rewards, writes Laura Slattery

It is an axiom of financial planning that in order to capture the rewards of the stock market, investors must first of all take a few risks.

But consumers browsing through the brochures and leaflets for tracker bonds could be forgiven for being confused: Some will grandly promise "unlimited" or "exciting" potential for growth, all while securing 100 per cent of the initial capital invested.

So where's the risk? If the risk-reward relationship holds true, there must either be one hidden somewhere or the "potential" returns highlighted by the sales fliers should more sombrely read "possible, but kind of unlikely".

The Irish Financial Services Regulatory Authority (IFSRA) is weighing up whether to introduce a code of conduct in relation to the advertising and marketing of tracker bonds and similar investment products, amid fears that consumers are being duped by the companies selling them.

The consumer director, Ms Mary O'Dea, believes that consumers' ability to make well-informed decisions on financial products may be compromised by the lack of information currently provided on some tracker products.

"Geared" tracker bonds, where consumers borrow money to invest in tracker bonds, were singled out for special attention last year when Ms O'Dea issued a warning on the dangers of borrowing to invest in products where the returns might not meet the cost of paying the interest on the loan in addition to any charges and early-exit penalties levied by the bond providers.

Tracker bonds are often designed in a way that makes it extremely difficult to achieve the "headline" returns advertised. Investors' money is usually tied up for up to six years, with no access allowed until the end of the term.

Responding to IFSRA's public consultation on the marketing and sale of the bonds, the Consumers' Association of Ireland (CAI) said providers should be obliged to clearly show the benefits, risks and features of each offering.

Consumer campaigner Mr Brendan Burgess said marketing literature for tracker bonds should include a prominent "key features" box alerting consumers to the nature of the products.

It is likely that any new code of practice will mean that consumers have to sign a declaration that they understand the nature of the investment and that they have received all the documents, however Mr Burgess does not agree with such suggestions.

"These requirements are usually complied with in a meaningless 'sign here' fashion. It is much better to highlight that the adviser is getting a commission which may affect their independence and the quality of their advice," he has written to IFSRA.According to the Consumers' Association, Irish tracker bond retailers typically take between 4-8 per cent of the investment in non-disclosed fees and commissions.

So what about the much-promised potential for greater growth? Can it be realised? Taking a look at three 100 per cent capital-guaranteed tracker bonds currently on sale illustrates how achieving the maximum potential returns advertised can be a tricky business, depending on huge strokes of good fortune.

First Active Select 50

The final return on First Active's Select 50 bond depends on the level of each of 50 stocks at maturity relative to its initial company share price.

The maximum potential growth on the bond, which has a minimum investment of €2,000, is 55 per cent gross over a four-year term and 70 per cent gross on a six-year option. But the return on the bond drops by 5 per cent for each company where the share price at the end of the term is below its share price at the start of the investment.

So on the four-year option, investors get nothing except their original capital back if more than 10 of the 50 stocks are below their initial share price level.

On the six-year option, if more than 12 of the 50 stocks have fallen by the end of the term, investors will get their capital plus a 10 per cent minimum return back.

While the potential upside on this bond is high, it is not difficult to see how investors' returns could be obliterated.

As it is close to impossible to predict whether any given stock, never mind 50, will be higher or lower in share price in four or six years' time, investing in this bond seems more like a 50-shot-in-the-dark gamble than an educated strategic investment move.

Standard Life Global Secure Bond

The performance on this six-year bond, which has two options, is linked to the share price of 25 companies.

Standing at €20,000, the minimum investment is a little higher than for most trackers.

Under the Secure option, investors receive 100 per cent of the performance of each share, subject to a maximum overall return of 45 per cent and a minimum return of 12 per cent (1.9 per cent per annum) before exit tax.

In exchange for sacrificing this minimum return safety net, the Capital option has a more generous maximum overall return of 75 per cent.

Read further and investors will discover that in addition to a maximum "overall" limit on returns, there is also an individual share cap of 45 per cent on the Secure option and 75 per cent on the Capital option.

This means the good performers cannot compensate investors for the bad performers, which will steadily drag down investors' returns.

In this bond, the opening value of each share is based on the average monthly price of each share over the first three months of the investment term, while the closing value will be based on the average monthly price of each over the final six months of the investment term.

This strategy is known as "averaging", a common tracker feature that IFSRA has suggested is not being fully explained to consumers.

However, Standard Life succinctly states both the pros and the cons in a "key features box", saying that averaging "aims to protect the value of your investment in a falling market but may restrict the gains you achieve in a rising market".

Ulster Bank World Balanced Bond

This bond is linked to the growth of five world stock market indices: the S&P 500 in the US, the FTSE 100 in the UK, the Eurostoxx 50 in the euro-zone, the Nikkei 225 in Japan and the Hang Seng Index in Hong Kong. The minimum investment required is €3,500.

The return on the bond is equal to 50 per cent of any growth over a three-and-a-half year term or 80 per cent of any growth in the basket after a term of five years, 11 months.

Like Standard Life, Ulster Bank uses averaging. The value investors receive for each index will be based on the average of the monthly closing levels over the last six months on the shorter-term version and the last 12 months on the longer one.

Unlike the Standard Life bond, which gives 100 per cent participation in the growth but caps it at a certain level, Ulster Bank gives a percentage of the growth with no cap.

So, in theory, there is no maximum return on this bond, which is a relatively simple tracker and offers a 0.25 per cent pre-tax bonus on maturity to those who invest before June 30th.

However, investors may still find it galling to see a portion of the growth disappear, especially when companies such as Mercury Wealth have, for limited periods, offered 100 per cent capital-secured bonds that give investors 100 per cent market growth with no caps on returns.