Tuesday 20 February 2018

Tracker bonds If you're looking for a guarantee on anything, it comes at a price

Charlie Weston

IN times of stock market turmoil and economic uncertainty, people understandably search for certainty. Stockmarkets have been collapsing in spectacular fashion this year, scaring off many from putting their money into shares.

This is part of the reason money has been pouring into tracker bonds lately.

But financial advisers have warned that tracker bonds may not be the best place for people to put their money. Some go so far as to say you should steer well clear of these products.

This is because they have complicated charging structure, and three- to six-year terms with interest rates that are little better than deposit rates.

Tracker bonds are fixed-term investments where the bulk of your money is invested in a deposit-based account. The rest is invested in the stockmarket.

The part that is invested in the stockmarket will offer a return based on the performance of a stockmarket index or mix of indices. An index, such as the FTSE 100, measures the performance a stock market.

You will usually have to invest a minimum of €5,000 and the term is fixed for between three and six years.

You will have no access to your money during this time, according to the National Consumer Agency.

Tracker bonds are usually considered low-risk investments because many of them offer 100pc capital security once you leave your money invested for the full term.

This means you are guaranteed to get the original amount of money you invested back.

However, even if you get all of your money back, you may have lost money because of the impact of inflation.

Generally, the lower the risk, the lower the level of return on your investment.

The return you get on the tracker bond depends on the growth of the stock market which the bond tracks.

There will usually be a limit on the amount of the stock market growth you are allowed, for example, a maximum of 50pc of the growth.

If you are looking for a guarantee on anything, it comes at a price, and the same is true of capital-guaranteed tracker bonds.

The attraction for many people of tracker bonds is the guarantee. For example, a guarantee that your capital is 100pc protected.

In most cases, you will sacrifice the possibility of a higher return for this guarantee.

This means the main disadvantages of investing in such a product, rather than the stock market itself, is the limited potential for growth.

Authorised adviser Eamon Porter, of Aspire Wealth Management in Malahide, Co Dublin, advises people to be weary of tracker bonds.

Such products usually lock in client monies for a fixed period varying from three years to six years, he says.

"The reason for the lock-in is due to the fact that between 77pc and 92pc of the investor capital (depending on the term involved and the prevailing interest rates) is placed on deposit for the complete term of the investment.

"The balance is then used to pay introducer commission, the cost of buying stockmarket options, as well as the profit margin for the product promoter, usually a financial institution."

If no growth is achieved on the stockmarket portion of the tracker bond, then the client receives only that amount which was guaranteed, usually the original investment.

Most such investors overlook the fact that their money actually incurs a loss in value due to inflation in the intervening period, Mr Porter stressed.

"Over time, these amounts to a significant loss in real value," he warned.

In many cases, you may emerge at the end of the investment period with either just the amount you put in or a return similar to that offered by a deposit account.

And it is not as if tracker bonds are without risk.

All tracker bonds carry what is referred to as counter-party risk, where the guaranteed return of capital is available only if the guaranteeing institution is still capable of fulfilling the return of capital.

If a financial institution's trading status is compromised, so, too, is its ability to give guarantees or, more importantly, fulfil them.

This counter-party risk is no different than that which exists if a person places money on deposit directly with a bank.

While the EU-wide deposit guarantee scheme is in place to protect up to €100,000 per person, any excess can be more at risk with one bank than another, depending on the bank's financial ratings, Mr Porter added.

Worth considering is the fact that deposit rates being paid by banks are very high, with a vicious rates war raging.

Some seven institutions in the Irish market are offering interest rates of more than 3.5pc for money deposited for a year.

It is also worth noting that tracker bonds are charged a higher level of DIRT (deposit interest retention tax), which means that interest earned is subject to DIRT plus 3pc, or 30pc in total.

Irish Independent Supplement

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