What's yours is guaranteed . . .: Whatever the adverts say, the new savings-equity products hold few benefits, reports Clare Dobie

THE FINANCIAL services industry reckons it has found a winner. It is called guaranteed equity investment.

It may sound like a contradiction in terms, but guaranteed equity investment is proving popular. The idea is that it allows savers to invest in the stock market and still sleep easy at night.

The success of guaranteed equity products - they have attracted pounds 500m so far - means investors no longer have to choose between shares and building society deposits. Sellers of guaranteed equity products say their products combine the best of both.

But there are plenty of critics. 'The public are being misled,' says one. 'Some are of questionable value,' adds another.

So is it a case of trick or treat?

There is no doubting the attractions of the guaranteed equity formula. Investors have been frightened off the stock market by successive shocks - Storm Friday, Black Monday, White Wednesday to name but three - and are wary about risking their shirts again.

Successive falls in interest rates are, however, forcing many to think hard about what to do with their money. A year ago pounds 1,000 in a building society was producing pounds 65 a year after tax. Now it is producing almost half that. To borrow from the ads, the penny is beginning to drop, literally.

At the same time the stock market has been making new records and some shares have doubled and even trebled in value since 16 September, when the pound was devalued. This has reminded investors of the money that can be made from shares.

If you invest pounds 1,000 with one of the growing number of companies selling guaranteed equity products, it typically promises to repay the whole sum at a later stage if the stock market falls and to give you about 95-100 per cent of any rise in share prices over the period.

Some firms claim to offer more. National & Provincial, for example, promises 'over 133 per cent of the stock market's performance with building society security'.

Too good to be true? National & Provincial declined to explain how it could make these promises. But other building societies say the bulk of the money invested through these products is put in deposit accounts and the minority in a call option on the FT-SE 100.

What the society does not say, however, is that the return is not 133 per cent but 100 per cent once tax is taken into account.

Others offer guarantees but it is not always immediately apparent that the guarantees cover only the nominal value of the capital. If you put pounds 1,000 into a typical product you will get the same pounds 1,000 back at the end of the investment period, usually five years later, but if the market falls you will not get any income.

Costs tend to be very high. Not only do suppliers usually pocket income that would have accrued, but they also offer less than the full extent - say 95 per cent - of the market rise. Some also levy upfront charges, with some as high as 13 per cent. The combined effect of these factors is to make many guaranteed equity products very poor value for money.

What would have happened to anyone who put pounds 1,000 into one of these products a year ago? Typically they would have seen the value of their investment rise by about 15 per cent. That might look attractive until you consider what would have happened to people putting the same amount into a basket of shares. They would have seen a return of about 20 per cent, including dividends. So they would have sacrificed pounds 50 for peace of mind.

What would have happened if the market had fallen? You might think that the guaranteed investor would have been better off, but you would probably be wrong.

If the market had lost 5 per cent of its value, investors in a guaranteed product would still have their pounds 1,000. But so would investors in a basket of shares, because their dividend income would more or less have made up the capital loss.

Only if the market had fallen by more than the dividend yield would the guarantee have produced more money. Is pounds 50 worth paying for this unlikely situation? The stock market has fallen by more than the yield only once in 15 years.

Some companies have introduced variations on the theme. Legal & General and Henderson, for example, offer guaranteed products in personal equity plans, making them more tax-efficient than most bonds.

Legal & General, Save & Prosper and Scottish Provident link returns to the performance of funds they manage rather than to the market as a whole.

Some allow you to withdraw your money early. But there is usually a penalty for early redemption. For example, Yorkshire offers 50 per cent of the market's rise after one year, 60 per cent after two and so on.

Many such variations have costs attached. Save & Prosper, for example, offers the choice of 98 per cent of the rise in the market or 90 per cent plus a lock-in formula that allows investors to hang on to each 10 per cent rise.

Often investors in guaranteed equity products have no idea how their money is being invested. Usually this is not their fault as the companies are reluctant to discuss it. They say that investors need to know only that they are buying a guarantee.

Robert Benson of Midland Life, whose bond has attracted pounds 165m and which also produces many products sold by other firms, said: 'We can't give too much away. We buy a collection of assets. Investors don't see the assets.'

Many would run a mile if they knew that part of their money was being invested in options, even if it was not being used for speculation. Options rather than shares provide the stock market exposure.

Of a pounds 1,000 investment, more than 80 per cent is invested in a deposit account or a gilt trading below par but due to be redeemed at par at the end of the period.

The rest of the money is used to buy a call option on the FT-SE 100 index. These rise in value with the stock market. As the options traded on Liffe are only short-term, most of the guaranteed equity product providers buy them over the counter - directly from firms that tailor them specially to cover the required period, usually five years.

Tim Breedon of Legal & General recalls that when he first started thinking of these products in 1989 he could not find enough firms prepared to sell long-term options. This is no longer a problem.

So far the over-the-counter market has proved large enough to absorb the huge chunk of one-way business arising from guaranteed equity products. Capacity could, however, become an issue, as many in the industry expect sales of these products to double this year.

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