With the introduction of Peps and latterly Isas, consumers have become more willing to accept wrapped products so that a complex and diverse range now exists to meet savers' needs.
Competition in the market has led to innovation but much of the drive and enthusiasm for genuine customer-driven product innovation has been lost. So where will the next driver for innovation come from? The answer, in part, will be guaranteed equity bonds.
Before looking at where we are going, it is useful to remember where we have come from. Cautious savers have traditionally looked to bank and building society accounts to provide them with a “safe” return.
Unfortunately, this sense of security is often misguided as many savers fail to realise that, unless the rate of interest paid is significantly above the rate of inflation, their savings are effectively eroded away in real terms.
Few consumers also consider the wider implications of such things as basic income tax planning.
For investors seeking security combined with improved returns, a range of investment products has existed including conventional annuities, fixed-interest stocks, permanent interest-bearing shares and guaranteed investment bonds. These all offer a safe haven but with returns that are unlikely to set the world alight.
The potential for higher growth is offered by a further group of products including with-profits bonds, products linked to direct equity investment such as unit trusts, investment trusts and Oeics – whether stand-alone or Isa-wrapped – corporate bonds and guaranteed structured products.
Direct equity investment is too risky for many investors, while with-profits bonds are too long term for many – and even bonds have a level of risk that some investors find unacceptable. However, most savers understand they will benefit from exposure to stockmarket-linked investments – hence the popularity of Peps and Isas, which have additionally benefited from tax advantages.
People over 45 now account for almost 80 per cent of personal wealth in the UK. As the baby-boomer generation moves into middle age, these investors will increasingly have more money to invest above the tax-free limits offered by Isas and will look for more efficient ways to maximise their returns while minimising their tax position.
This is why structured products are growing in popularity. They satisfy the medium-term needs of the investor as they are available for terms of between three and six years. Furthermore, they tend to provide a fixed income or fixed growth option.
Importantly for risk-averse investors, invested capital is protected to varying degrees while stockmarket performance remains reasonable. In addition, wrapping such structured funds in an Isa, pension or insurance bond facilitates tax planning opportunities.
This combination of favourable features explains why guaranteed equity bonds have attracted about £6bn over the last five years.
However, not all guaranteed equity bonds are the same. As far as the risk-averse investor is concerned, capital protection may be the most important feature. Recently, a number of providers have offered products which can hardly claim greater capital protection than the indices they track, while others hedge their bets by following multiple indices.
Some providers of equity bonds also guarantee the capital gain. Depending on market conditions, investors are offered the opportunity to lock into the growth achieved to date. Should the value of the bond fall subsequently, the locked-in gain is still guaranteed. This is usually offered at some point within the final 18 months of the life of the bond.
Many cautious investors who have taken the opportunity to lock in capital gains have welcomed the extra security offered.
However, the downside is that growth thereafter may be foregone and, when markets continue to rise, investors may well kick themselves for their over-cautious approach.
The wise investor would seek a structured bond which not only locks in the gains but also allows further upside participation in the chosen index between the lock-in date and maturity.
A guaranteed equity bond generally works by comparing index levels on the start date and end date. The uplift is calculated on the difference between the two levels.
Some products lock in capital growth while others seek to protect investors from sudden fluctuations in indices during the final six or 12 months of the product's life.
This is achieved by taking readings at fixed intervals throughout the last few months and calculating the final level as an average of these readings.
This back-end averaging is designed to protect gains made during the life of the product from sudden movements in an index and, while it cannot guard completely against a sustained decrease during the final period, it can soften the landing.
Unfortunately, some investors are put off by the fact that many guaranteed equity bonds are hedged by linking to a number of indices or a basket of individual shares in order to spread risk. Talk of derivatives and hedge funds usually brings to mind high finance and Champagne-guzzling City boys playing fast and loose with other people's money.
However, derivatives provide the foundation of most protected or guaranteed funds, where they are used to provide security against potential stockmarket reversals. Investors scared away from such products because of the perceived risk may well not realise that not only are they missing out on significant returns but their equity portfolio or collective investment, even if Pep or Isa wrapped, may well prove to be a riskier investment than a guaranteed equity bond.
Increasingly, investors are both attracted and satisfied by the risk and reward that these bonds offer and are happy to build their investment portfolios and, indeed, structure their financial planning around such products.
For others, guaranteed equity bonds are just the first step to building an investment portfolio as the experience gives them the confidence to invest in a variety of higher-risk products available.