INVESTMENTS:With bank deposits offering decent returns, would investors be better off keeping their money in simple deposit accounts, or are there better investment instruments around?

FOR THE amateur investor, capital guaranteed products can seem like the ultimate safe harbour in a stormy sea of investment possibilities. In addition to protecting your initial investment – sometimes by up to 100 per cent – these products also offer investors the potential to gain from any upside in global markets. Unsurprisingly therefore, Irish investors are rushing into protected investments, and investment managers are rushing to meet the demand by launching a plethora of such products.

However, given higher than average fees plus poorer than expected performances, are risk-averse investors being scammed by promises of guarantees? After all, a typical capital guaranteed product needs to produce returns of about double that on offer in an An Post savings bond just to match its return – so would investors not be better off simply keeping their funds in a simple deposit account?

In general, there are two types of guaranteed products. Tracker bonds, which run for a fixed term of about three years and provide capital guarantees of up to 100 per cent, invest the majority of your money in a low-yielding capital-secure product and the remainder gets exposure to a stock market through the purchase of an option. Protected funds, on the other hand, lock-in returns when the fund is performing well, thereby protecting a proportion of your investment.

Financial adviser Simon Shirley tends not to favour capital guaranteed products, arguing that while in the past they have worked well because markets were booming, they can exert a heavy price in terms of liquidity, which isn’t justified by the returns they tend to generate.

“You’re sacrificing liquidity for the potential of earning returns in excess of that which you’d get on a bank deposit, but the returns don’t compensate you for tying your money up for the medium- to long-term,” he says, adding, “returns often don’t greatly exceed returns you’d get on deposit”.

Indeed returns are particularly poor at present. According to MoneyMate, up to September 10th Irish guaranteed funds have returned just 1.2 per cent on average, or 1.8 per cent in the previous 12 months. Worse however is their three-year performance, which is in the red to the tune of 11.4 per cent.

And on top of such dismal performance, investors also have to digest high charges, as funds providers feel entitled to charge higher than average fees in order to compensate them for the protection element of the product.

For example, at Eagle Star, for lump-sum investments the annual management fee ranges from 1.5 to 2 per cent on its range of protected funds, while an early encashment charge applies if you should cash in your policy in the first five years.

Friends First charges 1.85 per cent on its Protected Equity fund, Irish Life has a fee of 1.5 per cent on its Securescope fund, while at Liberty Asset Management, annual charges are as much as 2.35 per cent for its protected funds range.

So straight away you would need your fund to be returning about 2 per cent just to break even, while any losses the fund incurs are exacerbated by the presence of charges.

But, you might argue, given that your product is also exposed to equity markets over the term of the investment, it still has a chance to out-perform. After all, isn’t this why you chose it over a straight-forward deposit account?

Well, this might be true if your fund was actually invested in the markets, but most funds-providers have your money tucked away in safe cash instruments – where it might not actually produce any returns, but at least it won’t cost the fund manager anything when you come to collect on your guarantee.

Take Eagle Star, for example. Its Protected Balanced fund, which it launched in September 2006, promises investors an allocation of between 0 and 90 per cent to its Balanced Fund (which itself only has a limited allocation to equities, with about a third invested in cash and bonds), but currently holds about 86 per cent in cash. So, you’re effectively paying out up to 2 per cent in annual fees for almost 90 per cent of your money to be held in cash. And, as Shirley points out, the cash instruments chosen typically return less than bank deposits – which accounts for the less than stellar returns currently on offer from such products.

Of course investment managers might argue that the low allocation to equities is due to the current market turmoil and the risks inherent in investing in such assets now, but you would still expect your investment to at least match what’s on offer in bank deposits.

Investors should also be aware that many product-providers outsource the provision of a guarantee to a third party and so should do their due diligence on the security of this provider – after all, failed investment bank Lehman Brothers offered capital guarantees on a number of Irish Life’s products.

So, given the various downsides, if considering a capital guaranteed product, Shirley recommends that you make your decision carefully. “You have to look at the terms of each investment, how the guarantee is given, the security of the provider, as well as evaluating the impact of fees and lack of liquidity.” He adds you should also weigh up how they compare with bank deposits and An Post savings.

Well, based on the aforementioned current performance, they stack up rather poorly. An Post, for example, offers a return of 10 per cent tax-free over three years on its savings bond, which equates to a return of about 13 per cent if tax at 25 per cent was to be deducted from the interest earned. And when you add the typical charges of a guaranteed structured product, returns on this product would need to be of the order of almost 20 per cent over three years to match the An Post product – but given the constraints above, this appears unlikely in the current environment.

And bank deposits are also offering decent returns at the moment, with providers such as EBS for example, offering rates in excess of 3 per cent.

But what to do if you can’t afford to lose much of your investment – but you still want the possibility of earning returns in excess of what a deposit account is paying out? Well, Shirley suggests you construct something similar to a capital guaranteed product yourself – by putting 90 per cent of your investment into a deposit account, and the remaining 10 per cent into an equity fund.

This way, you can, for example: avoid paying steep charges on the majority of your investment; your capital will be 90 per cent guaranteed; returns on 90 per cent of your investment will be guaranteed – and you still have the possibility of out-performance on the 10 per cent that you have allocated to equities. In addition, you will also likely benefit from the Government’s guarantee of deposits.

So a little bit of a do-it-yourself approach may be the key to better returns.