Seal of approval that doesn't offer security

The aim is to make saving simpler and cheaper but it may increase the risks, says Andrew Verity

When the Treasury brought out its latest plan to encourage low earners to save this week, one high earner - bearded, with a toothy grin and open-necked shirt - was especially pleased.

Richard Branson's happiness sprang from a plan to give government endorsement to savings products just like the one offered by his own firm Virgin Direct. His mood was in stark contrast to the rest of the investment industry.

In a consultation document titled "Making Saving Easy", the Treasury took an unprecedented step in its drive to encourage all of us save more. It proposed to give a stamp of approval - a benchmark - to savings vehicles which are simple, cheap and accessible.

Savings companies will be able to display the benchmark only if they offer an Individual Savings Account that meets prescribed standards. When it is introduced in April, the ISA will offer tax-free income and potential growth to savers who put their money in cash, insurance or stocks and shares.

The reason the document has pleased Mr Branson is simple. Virgin Direct will sell ISAs that invest in "tracker" funds - funds which copy the movements of an index such as the FTSE 100 index of leading shares. Most other funds are "active managers": they pick shares by researching which companies have the best prospects. To Mr Branson's pleasure, share investments will get the benchmark only if they are tracker funds.

The plan is designed to make it easier for savers to navigate their way through the maze of over 14,000 savings vehicles in the UK. Helen Liddell, the Economic Secretary to the Treasury, said the benchmark "will be easy for people to understand and so help them avoid making poor choices".

The plan appears simple. Investors can save up to pounds 5,000 a year tax-free, with a maximum of pounds 3,000 in cash, pounds 1,000 in insurance-based savings, or pounds 5,000 in unit trusts. But the benchmark will go only to cash deposits, unit-linked insurance or tracker funds - because these are simplest and cheapest.

But are the simplest products the best? Not according to the savings industry. Tracker funds are simple and cheap, they are also quite risky. If consumers believe they carry government approval, the industry warns, they could feel seriously misled when the market dives.

At the heart of the problem is the cost issue. Mr Branson argues savers have lost billions by paying for six-figure fund managers to underperform the index. Paying for a unit trust that tracks an index may cost as little as 0.3 per cent of the investment. Paying an active fund manager usually costs at least 1 per cent.

But in spotlighting low costs, has the Government overlooked the question of risk? AUTIF, the unit trust trade body, complains savers who want a stake in the stock market will be pushed into one of the most volatile types of investment. Unlike active managers, managers of tracker funds must follow the stock market's every move, even when that's downwards. If the market plunged, savers could be stuck in a vehicle that lost the maximum, not the minimum, amount of money.

The Treasury says in its consultation document (in a tone that some perceive as patronising): "ISAs which meet the benchmark standards must be clear and simple, so that they are easy for ordinary people to understand."

But what if us fumbling, ordinary people get it wrong? What if ordinary people are so simple that they mistake the "benchmark" for a guarantee?

Philip Warland, director general of AUTIF, says: "I do not believe the Government can benchmark a unit trust without giving the impression it is endorsing the product and that the product has wide-ranging suitability for almost all people. The consequences we fear are that people will buy benchmarked products, taking the Government's word, but will have insufficient warning about the one remaining risk in the product, which is the performance.

"If we were to have a substantial market correction or, even worse, the sort of crash that occurred in the 1970s, when the stock market lost nearly two-thirds of its value, we can be absolutely certain that investment funds would look for somebody to blame. We suspect the Government will be nowhere to be seen and the regulator will be seeing whom it can fine."

The Treasury says the aim of benchmarking is to avoid any nasty surprises for the customer. The products can be cheaper because they are so simple there is no need for advice: no hidden costs, no strings attached, no notice period and nothing damaging in the small print. As most in the savings industry admit, these are good principles, but removing the cost of advice has its own price.

Steve Muir, spokesman for Axa Sun Life, the insurance giant, said: "There's a lot of mention of how we won't suffer any nasty surprises. But people who are in a tracker fund when the market falls could have a very nasty surprise. What most people tend to be afraid of isn't a nasty surprise in the small print, but a nasty surprise on the markets."

Those who want a share investment but fear a stock market crash have flocked increas- ingly over the last three years to savings vehicles that limit this risk. A whole swathe of products - including with-profits savings, protected funds that guarantee return of capital - fit the bill. But none of these will carry the government endorsement.

Further, investment trusts - which differ from unit trusts in that they are set up as quoted companies - have been left out of the equation. Big investment trust providers, such as Fleming and Foreign & Colonial, point out that many investment trusts have lower charges than unit trusts - running directly against the Treasury's reasoning. They even provide cheap access to tracker funds.

Don Clark, managing director of Pep Direct, a leading savings adviser, complains that the government seal of approval will be absent from many of the best products available to a low-risk investor. "Explaining to individuals that the ISA they are being advised to invest in does not come with the government stamp of approval - despite being the best one for their needs - will be a ridiculous state of affairs."