Investment

3 April 2007

Reader Writes:

I read your article on BRIC funds and wondered if you considered them to be high risk or not and whether there was a way to invest there but not suffer the risk.

Having your cake and eating it is a common chirp from parents to children. I confess to being over 35 before I realised what it meant.

Risk planning within investments is no different. With every decision in life there is a potential for return that is broadly equal to the potential for loss. There are times that this loss can be minimised and the use of certain financial instruments can assist that. I will explain that later.

My recent column pointed out that BRIC economies are seen as the economic powerhouses of the next few decades. This follows a Goldman Sachs report in 2003. The main finding of the study was that by the year 2050 the combined share in global gross domestic product of these four economies is set to double. China is seen as the production plant, Russia the energy store, Brazil the commodities warehouse and India the service centre.

The drive has sent commodity prices raging and some commentators believe they have a long way to go.

From a risk point of view, commodities, just like technology are prone to bubbles - i.e. euphoria that is created in an economic cycle that is allowed to be blown out of proportion, until it's blown out of sight by the inevitable pop.

Whilst it is an area of huge potential, that potential is down as well as up.

A way to protect that is to consider a protected investment. Whilst I don’t normally like any of these arrangements, for most, accessing commodities direct will be outside their risk parameters.

There is a protected investment which offers investors two 6-year investment options linked to the price movement of eight equally weighted industrial metals and energy related commodities. The underlying asset base (the portfolio) has a weighting of nearly 40% in various forms of oil and gas (Brent crude oil, natural gas and WTI crude oil) and over 60% to a range of base metals (aluminium, lead, copper, nickel and zinc). One option provides 100% capital protection at maturity with a 165% participation linked to the growth of the commodities portfolio above. 1.

The second option offers 90% capital protection at maturity in exchange for a 190% participation in the growth of the portfolio above. 1.

At maturity, capital will be repaid in full provided that the average price of the portfolio has not fallen below the initial starting point. If at maturity the final level is below the starting point, capital will be reduced by 1% for every 10% fall up to a maximum of 10%. Consequently a 30% drop in the portfolio will result in a capital reduction of 3% at maturity. 1.

This provides you with good downside protection against the markets whilst actually giving you an uplift of up to 190%. If the average value on maturity of this portfolio is a 100% return you would receive 190%. 1.

Commodities are typically uncorrelated with equities, which gives you a diversification that you would not normally have. It's like investing in an ice cream company whilst investing in a Wellington boot company, allowing you not to have all your eggs in one basket.

Whilst the vast demand for raw materials continues to be driven, and increasingly reliant, on the rapidly expanding economy of both China and India, it could slow, or there could be a marked increase in supply which could have a negative impact on prices. You should only invest into the plan if you can hold it for six years. If you tried to access this beforehand the protection would not apply. The plan closes for investment on the 20th of April.

Source 1: Sesame New Product Fact Sheet March 2007

Worldwide Financial Planning Ltd who are authorised and regulated by the Financial Services Authority. 'The FSA does not regulate Credit Cards, Will Writing and some forms of mortgage and Inheritance Tax Planning.'
Information given is for general guidance only, and specific advice should be taken before acting on any suggestions made.
All information is based on our understanding of current tax practices, which are subject to change.
The value of shares and investments can go down as well as up.

03/04/07