The safe side of the street

For the risk-averse investor, guaranteed-growth bonds look good

Investors seeking capital growth as opposed to income are often drawn to the limited-issue "guaranteed- growth bonds" offered by a number of insurance companies. Guaranteed-growth bonds pay no income, and like guaranteed-income bonds they do not protect you against inflation or rising interest rates, but they do guarantee the return of your original capital, plus a fixed rate of growth paid out when the bond matures.

Insurance companies that have issued such bonds in recent months include Black Horse Life, Eurolife, Hamilton Life, NatWest Life, Pinnacle Insurance, Reliance Mutual and Zurich Life. The minimum investment is typically around pounds 5,000. The bonds are generally issued by the newer or smaller insurance companies, but investors' cash is protected by the Policyholders' Protection Act, which guarantees a 90 per cent payout in the event of the insurance company failing.

Returns are all paid net of basic-rate tax, which makes the projected growth look even more attractive. However, non-taxpayers cannot reclaim the tax and higher-rate taxpayers have to stump up the difference between basic-rate tax and their own tax rate.

These variations on the "guaranteed" theme are lump-sum investments, and so are not suitable for regular savers, and generally offer fixed returns over a set period - usually five years.

Guaranteed-growth bonds have proven extremely popular with many investors not prepared to take risks with their cash. There has been a trend towards the long-term assurance of growth, as opposed to the roller-coaster rise that is offered by direct investment in the stock market, and guaranteed- growth bonds currently offer better rates of return than many savings vehicles that carry a similar degree of security, such as building society accounts.

For seriously risk-averse investors it is worth noting that many of the guaranteed-income bonds offered by the life companies are in effect growth bonds - in that they offer the option of having the income reinvested to produce guaranteed gains. Johnson Fry's Income Bonus Bond is a typical example. Offered in conjunction with Financial Assurance Company, it gives an annual return of 8 per cent or an accumulated return of 55 per cent over five and a half years. It is available until 17 May, but Johnson Fry says it will be launching a new bond from 26 June.

Also coming up is a new bond from Eurolife, which is expected to be similar to its recent 60 per cent growth bond over five years. Independent financial advisers will be able to keep investors informed of further upcoming issues in the bond world.

The main drawbacks with these bonds is their inflexibility. Generally, you will forfeit any of the guarantees offered by the bonds if you are forced to cash them in early. That means you must be prepared to sit out the full length of the bond's term to get the benefits.

Locking in at the wrong fixed rate could also be a mistake if rates subsquently rise, leaving your return looking paltry. Despite that, the bonds issued this year have proven to be very popular.

"Guaranteed or low-risk investments are of interest to the majority of our customers, who are generally risk-averse," said Paul Stott of NatWest Life. "They are of most interest to those people who want to invest capital for a specific term in a low-risk environment such as those who are just approaching retirement and who, at the end of the term, plan to draw an income from their cash when they subsequently reinvest it into, say, an income bond or a corporate bond PEP."

Guaranteed-growth bonds that offer a fixed gain at maturity should not be confused with guaranteed-growth bonds linked to the performance of the stock market. These offer investors the guarantee of their capital back, plus a percentage of growth according to how much the stock market has risen. However, if the stock market falls, there will be no growth, just the return of the original capital.

GA Life's Guaranteed Security Portfolio is a typical stock market-linked guaranteed growth bond. Three-quarters of the fund is invested in equities, with the remaining 25 per cent in fixed-interest investments such as gilts. "It's aimed at people who want to get into the stock market but who don't want to lose their shirts," said Ian Harper of GA Life. "The safety net means that investors never get less than their money back as long as they invest for five years."

Buyers of these products should note that it is your capital that is "guaranteed", not the growth!

One aspect of equity investment that holders of these bonds miss out on are the dividends paid by many stocks but, then again, the holders are not risking their money (unlike those in income bonds linked to stock market performance).

Another potential drawback is the fact that many of these "growth" bonds only pay out a percentage of any growth in the stock market, in effect putting a cap on how much money investors can have.

For instance, Black Horse Life's Premier Bond, which is available to new investors until 16 May, offers the greater of either 125 per cent of the original investment or 60 per cent of any growth in the FT-SE 100 Index over the six-year term of the bond. NatWest Life's Guaranteed Growth Plus Bond offers a similar minimum return of 125 per cent, but a maximum return of 170 per cent, over five and a half years.

Recently we have seen the launch of guaranteed-growth bonds investing in other markets. The Japanese stock market, for instance, was tipped to be one of 1996's star performers, which prompted a flurry of bonds investing in that part of the world. Save & Prosper offered a Japanese guaranteed stock market bond providing 120 per cent of the average growth of the Japanese market over three and a half years. This was followed by the Lotus Bond from Sun Alliance, based on the performance of the Nikkei Stock Index 300. It offered to share out growth of at least 135 per cent over five years.

These stock market-related growth bonds are really aimed at the slightly more sophisticated investors who are happy linking their investments to stock market returns.

Independent Financial Advisers David Aaron & partners are offering Independent readers a free eight-page booklet covering all aspects of guaranteed bonds. Call free on 01908-281544.