Create your own guaranteed fund

I realise that many people have lost confidence in the stock markets and have doubts as to when it will show some continued signs of revival. As a result, there is a great demand for guaranteed funds.

About a year ago, I wrote that I was not a great fan of this type of investment and, a year later, I have no reason to change my mind about the majority of those on offer.

As someone who has been involved in marketing for major international banks, I can recognise that they are a marketing man's creation.

They feed on clients' fears of loss, but in my mind, give the investor a poor deal. In fact, the investor would be far better creating his or her own guaranteed fund than that offered by most suppliers.

It reminds me of my days in banking 30 years ago and the introduction of automated teller machines where clients could obtain money from banks 24 hours a day. A great convenience, which we all use, and are absolutely sold on, because of the huge marketing spend that banks' employed both then and now.

In fact, the real reason for the introduction of these machines was as a cost saving project for the banks' as they do not have to employ as many counter staff and the cost of an automatic transaction was a tenth of the cost of a manual one. Perhaps, they want me to use it to deposit cheques into my account; the time I have to wait to see a teller at my bank.

Anyway, enough reminiscing, back to the guaranteed funds. Originally, the funds promised a minimum return of the capital invested at the end of a set period and a percentage of any growth linked to a stock market index.

This was achieved by placing the majority of the investment into fixed interest stocks, like a bank deposit or treasury bills, which at the end of the set period, when the interest was added, would bring the deposit back to the amount of the investor's initial deposit.

The remainder of the investment would be used to buy a derivative that would give the investment company the right to purchase the index at the end date for the fund at the price of the index at the start date.

However, as only a small amount was used for this purpose only a percentage of any gain was paid out, if there was any gain of course.

This proved to be very popular and so more and more banks, especially, started offering this type of investment, with the consequence that a new angle had to be found. Hence, the small guaranteed return on top of the initial capital that we see advertised every day in our newspapers.

So working on what you now know, you will be able to work out that to achieve this even more money has to be placed into the safe portion of the fund.

However, as interest rates have reduced since last year, another form of vehicle other than bank deposits or treasury bills has to be found or the fund must be for a longer period.

Hence, you will now find that guaranteed funds are for four, five, six years and sometimes much longer periods. Often, too the guarantee is provided by investing in zero-coupon bonds, a less secure investment than the two already mentioned.

The other problem is that if the fund is linked to an index, and a derivative has been bought for a set period, there can be no market for your units if you wish to withdraw before the end date of the fund.

Therefore, not only do you have no guarantee but, also, you are totally reliant upon the fund issuer to give you whatever price they wish, because it is extremely unlikely that they will be able to re-sell your units.

If you really wish to invest into this type of fund choose one that actually invests in a fund and not linked to an index. This means that if the fund price has increased you can come out, even if there is a small penalty for doing so, before the end date.

I said earlier that you should consider creating your own guarantee fund and I hope you can now see what I mean. Say you have $100,000 to invest, why not place $80,000 into a with-profit bond with a leading insurance company.

Most funds should return at least an average of 5 per cent per annum over five years; past returns have been substantially higher than this, and will provide $102,103, i.e. your capital plus a small return over the period.

The remaining $20,000 you can invest into a mutual fund of your choice, rather than the investment company's, and obtain 100 per cent of any profit rather than a percentage.

If this does not appeal never mind, it means that you are keeping a lot of financial marketing people, like me, employed.

The author is the Head of Retirement and Relocation, Towry Law International, Dubai.