I read your article about protected products and wondered if you had a view on the new protected investments that are being offered. They were explained to me as a plan that guarantees your investment at the end of the term plus a minimum of the best return the investment has achieved over the term – seems like a cake and eat it.
I have been to the odd party and didn’t much like the cake and this party is no different. Protected investments in my opinion are nothing more than a product sold by people who cannot sit down and explain what the word risk means to an investor.
For some, the word risk means loss of money and for those who have had it explained; it will mean fluctuation of your capital in pursuit of your gain.
Whilst choosing to walk somewhere will clearly be the safest, it can become cumbersome for some people when they reach water and is also a lengthy process. A flight will take you quicker, but the potential turbulence can be off-putting.
The type of investment you are referring to above is called constant proportion portfolio insurance. It is as exciting as sucking a sweet with the wrapper on and still in its cardboard box. It really must have been a challenge for the marketing boys to make that look pretty.
Let me explain how it works and why it’s flawed. In its marketing form it appeals to your emotions of fear and greed. You are told your money cannot go down and also that your investment will give you the best price the policy achieved during the term of the plan – fill your boots!
With concrete unfortunately! The funds referred to use a complicated system that spreads your capital daily between risky and non risky elements with a guarantee that your capital will never fall below a certain level. The system operates by daily adjusting the balance between underlying equity and cash in response to the difference between the current price and the protected price. So for example you have invested and the price has gone up well, so the greater the gap, the more capital can be put at risk and consequently the equity content is increased. As markets fall, the gap between current price and protected price falls and as a consequence the amount of capital that can be invested in equities falls too, and this is a disaster.
Naturally there is the chance that the market would drop so quickly that the fund couldn’t be disinvested in time to take care of the protection. As a consequence the plan may now be below the protected price and of course would now be invested fully in cash and cash-locked as it is not able to take any equity risk.
At this point gap insurance is supposed to kick in to bring the capital up to the protected price. The truth is this insurance is paid for by you within the plan, and is against considerable market falls. There is no guarantee that the third party counterpart will honour the insurance so in theory such plans will remain cash locked with a long process waiting for the capital to return to the protected level.
If I haven’t put you off sucking sweets with wrappers on consider the following: Whilst you sat cash-locked or indeed when the market fell, normal investment theory would have said to buy more equities as they are now cheaper. This plan mysteriously works on the basis of selling equities after they have fallen and buying more when they have risen – complete and utter madness and a guarantee to lose money. They do not benefit from dividends (you might expect c3% per year) and the protection does not include the charges they take so keep your hand in your pocket.
For a free fact sheet on investment call 0800 0112825 or email info@wwfp.net
Reference: Constant Proportion Portfolio Insurance (CPPI) Fund Review R07-034, May 2007. Sesame Research.
The value of shares and investments can go down as well as up
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