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GEB ready to rumble

The strong performance of markets over the last few years has lulled many

investors into regarding equity investments and in particular index tracker

funds, as a safe bet. However, recent turbulence in the market and the

fall of some dotcoms from grace has begun to wear away at investor

confidence in direct equities and investors have begun to look around for

other, “safer” alternatives.

These alternatives range from “risk-free” building society accounts to

more complex investment products which contain a degree of inherent risk.

Although many investors may be tempted to flee the equity markets for a

building society account, they should be wary. Money on deposit rarely

earns after-tax rates of interest significantly above the rate of

inflation, effectively eroding investors&#39 money away in real terms.

Instead, investors should certainly consider some of the ever widening

range of investment products available. Some low-risk/low-volatility

products are only suitable as long-term investments – for example,

with-profits bonds offered for many years by the likes of Britannic and

Prudential. The smoothing effects of with-profits iron out many of the

peaks and troughs of equity investing while the conservative nature of most

with-profits providers means capital risk is low. However, the long-term

nature of these investments makes them unsuitable as a stopgap solution

while equity markets are volatile.

Shorter-term products which also offer a higher yield include junk bond

funds and guaranteed equity bonds. Although the term junk bond implies

tomany investors&#39 minds an unacceptable level ofrisk, as investments they

merit careful consideration as many are underwritten by highly reputable

institutions such as Orange.

Until about eight years ago, there were few products which combined a good

degree of capital protection with good returns over the short to medium

term. Guaranteed equity bonds and other stockmarket-linked investments are

now offered by a number of providers although such offers may not be

continuous throughout the year. They are usually available over terms of

between three and six years and provide either fixed income or a fixed

growth option although the final capital is linked to one or more

stockmarket indices. Importantly for risk-averse investors, invested

capital is protected while stockmarket performance remains reasonable. In

addition to good returns and capital protection, they can provide

short-term flexibility.

Although GEBs have existed for just over 10 years, their combination of

features goes a long way to explaining why they have raised about £5bn

over the last five years. Over this time they have evolved into a variety

of forms. Some GEB products guarantee a capital gain.

Depending on market conditions, investorsare offered the opportunity to

lock into thegrowth achieved, guaranteeing the capital gainto date. This

safety feature appeals to many investors who are prepared to forgo possible

future growth for security.

Others seek to protect investors from sudden fluctuations in indices

during the final six or 12 months of the product&#39s life. The second is

achieved by taking readings at fixed intervals through out the final period

and calculating the final fix as an average of these readings. This

back-end averagingis designed to protect gains made during the lifeof the

product although it cannot guard againsta sustained decrease during the

final period.

The latest generation of GEB-like products is designed for current

uncertain market conditions. They aim to combine headline-beating growthor

income with a reassuringly reasonable level capital protection.

One such product is the Extra Income & Growth Plan 3, from NDF

Administration with the plan assets backed by Abbey National Treasury

Services. It offers a combination of excellent returns, flexi-bility and

tax efficiency, all underpinned bya high level of capital protection in an

investment plan. This plan was launched on June 1 (closing July 21),

provides tax-free growth of 31 per cent (fora basic-rate payer, 38.75 per

cent gross) or anincome of 10.25 per cent (equivalent to 11.53 per cent

gross for a basic-rate taxpayer) a year (quarterly 2.37 per cent,

equivalent to 2.67 per cent gross fora basic-rate taxpayer).

As with many GEB funds, the outstanding combination of returns and capital

protection offered by the Extra Income & Growth Plan 3 is based upon the

use of derivatives. Unfortunately, the term still implies “risk” in the

minds of many investors. However, such a product, in uncertain market

conditions is actually much safer than a tracker fund.

The combination of capital protection of 100 per cent unless the market

falls by more than 25 per cent, together with the guaranteed 31 per cent

return at the end of the three-year term means that, should the market

slip, it would have to more than halve for an investor to have been better

off in a tracker fund. Conversely, should the market rise, it would haveto

do so by more than 31 per cent for the tracker to beat such a product.

With current conflicting opinions and uncertainties regarding stockmarket

performance over the next few years, an ever growing number of investors

will be seeking alternatives to direct equity investments. Such investors

should carefully consider whether a GEB might not prove to be the less

risky investment in the long run.

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