Every investor would love to be able to invest 'risk free' especially in the stockmarket where if you get it wrong losses can be financially damaging.
The banks and financial institutions have therefore started to market so-called structured products. These mainly come in the form of what are called Guaranteed Equity Bonds, GEBs for short.
GEBs offer to guarantee the original capital invested (in the stockmarket) while letting investors share between 100% and 130% of any gain, usually over 5 years.
But investors should be cautious when considering these bonds or funds and understand who is taking the other side of the trade. All these products are devised and designed by real experts, the so-called 'rocket scientists' of the financial markets.
And if anyone knows how to stack the odds in their favour and come out with the better end of a trade, it's the banks.
How Guaranteed Equity Bonds Work
On the face of it simply;
- You invest say £1,000 in a 5-year GEB which pays out 125% of a stockmarket’s gain, say the FTSE 100
- Your initial £5,000 is also 100% guaranteed should the market not rise or fall over the 5-year period
- Therefore if the stockmarket rises by 50% over the 5 years your return will be 62.5% or £1,625 (remember the bond pays out 125% of any gain (62.5% is 125% of 50%)
- If the market falls by say 30% over the 5-year period you'll get back your £1,000
- It is important to note that dividends are not included, nor is any interest paid on the original investment
Disadvantages of GEBs
- No dividends is a real stinker because stockmarket dividend income usually yields an average of 2%-4% a year, and that return compounded over 5 years adds up
- Sure, the original investment is guaranteed but at what cost? £1,000 in today's money will be worth less in purchasing power in 5 years. This is because inflation erodes the value of money overtime
- Contrast this to the return one would get with £1,000 invested into Gilts (Government Bonds) over the last 5 years. That would have paid back around £1,225 which is risk-free (in fact, the risk is far higher on GEBs because they're not backed by the government whereas gilts are)
- Money is locked up for the term of the GEB, usually 5 years. They come with no early redemption clauses
- Tax - All returns from GEBs are taxed as income and NOT capital gains (CGT). This can both be an advantage and disadvantage depending on your tax situation so this point is worth talking over with an accountant or tax adviser
Why Do So Many Financial Advisers Shun GEBs
It is interesting to note that many IFAs (Independent Financial Advisers) refuse to recommend GEBs to their clients. This is for two main reasons –
- Whereas GEBs seem simple to understand, the small print is notoriously difficult to comprehend. And if a professional adviser can’t make head or tail then how can he justify selling it to clients
- No two GEBs are the same. For example, they are all tied to different stockmarket indices (some the FTSE All Share, others the FTSE 100 etc), have different timescales, have different payouts and a myriad of other different points. It’s therefore hard, if not impossible to compare like with like.
Summary
Although we're nervous about GEBs and other similar structured products we're also sure there must be a few that are fairly good investments. So if you're looking to invest you’d be strongly advised to do as much research as possible into a whole range of different GEBs.
One research method we'd advise is to do plenty of 'what-if' type scenarios. Work out if the FTSE rises and falls by 10% increments over the 5 year period and see what the P&L (profit & loss) would be versus other investments such as cash or a basic equity fund.
Failure to do this work will probably mean the bank selling you the product will get a far better deal than you.
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