William Kay: Market must meet rising demand for protected bonds

As the Investment Management Association this week declared another month of poor sales of individual savings accounts (Isas), the contrast with sales of so-called protected investment funds remains stark. It is clear that, in these uncertain times on the stock market, there is a huge underlying demand for such funds, which offer a degree of protection against loss in return for the investor giving up some gains.

When these funds started out, greedy and short-sighted marketing managers chose to emblazon their advertising with suspiciously tempting rates of interest whilst suppressing the danger of high losses. These were the presciently named precipice bonds, and quite a few have duly fallen off the precipice as shares in London, Europe and the US have triggered losses in the options contracts on which these bonds are based.

Slowly the marketing departments' greed has been curbed by the ensuing bad publicity here and in other papers. So these bonds have been more conservatively designed, offering lower prospective profits and losses. Now more are following the seven-year lead of Close Brothers by guaranteeing the cash value of the starting investment. Close Brothers' Escalator 100 unit trust locks in part of any gain in each three-month period, keeping some back to guard against future losses. This is not unlike the smoothing principle which guides with-profit bonds, except that it is much more transparent.

I do not think protected bonds are in anything like a final form. I would like to see not just the initial cash value guaranteed, but also a reasonable rate of interest, say three per cent in current conditions, so investors would know they would be doing as well as a good bank deposit account. That would still leave room for some upside.

But it would be more important for an authoritative body to lay down minimum terms for these investments. The Financial Services Authority is remaining aloof, and that may be the correct stance for them. The market is, after all, raising standards unaided. Setting standards is more a job for a trade body which would exclude rash, reckless and rapacious providers.

As with with-profit bonds, protected investments are largely an exercise in delusion, that money can be exposed to the stock market without risk. But, if that is what investors want, the market should find a responsible way to meet demand.

* Word reaches me of the Treasury's latest musings over the much-vaunted and long-awaited suite of foolproof investment products foreshadowed last summer by the Sandler report into long-term savings. I am not hearing "yippee".

In the search for a one-size-fits-all solution, the Treasury is clearly sliding towards the low-risk end of the spectrum. So low, in fact, that a bank account is beginning to look positively racy by comparison.

It is understandable that a government department, and one whose reputation rests on probity above all, should not want to be associated with an investment device that causes any of the public to lose money.

The trouble is that being cautious does not absolve it from the charge of funnelling investors into something that will deny them gains if the stock market takes off. We are talking about long-term investments held through good times and bad. Look at what happened to government fixed-interest bonds, especially War Loan, when inflation took off in the Seventies. It was in response to that disaster that the then government introduced index-linked gilts.

It is, in other words, impossible to avoid risk, political as well as financial. Gordon Brown, the Chancellor, may be long gone to the House of Lords by the time the problems appear. But that will not save the poorer savers, at whom the Sandler savings products will be aimed, if they fall further behind those who can afford to reap the long-term benefits of the equity market.

w.kay@independent.co.uk

William Kay is personal finance editor of 'The Independent'