A guarantee is not always a sure thing

INVESTORS and their advisers should not be lured into capital guaranteed investment options by the continuing uncertainty in the world’s equity markets.

That is the warning from Louise Biti, the research and technical manager at ING, who says guaranteed investment options are becoming increasingly popular as disgruntled investors look to turn back the tide of investment losses that have become commonplace over the last 12 months.

Biti says investors should not “rush blindly into what looks like a sure thing,” arguing that guarantees do not always ensure the best return, and that they will always come at a cost.

“A guaranteed investment is a bit like a free lunch: you know you’re going to pay for it eventually,” Biti says.

According to Biti, the true cost of a guaranteed product can come in a number of forms. If the guarantee is attached to a cash or fixed interest investment, then the cost is that such products have historically produced lower returns, she says.

In other cases, guaranteed products will simply charge an extra fee.

Or, in the case of geared products that offer a capital guarantee, the cost comes in the form of higher interest rates, Biti says.

And it is geared products with capital guarantees that Biti says investors and financial planners should be particularly wary of.

“Guarantees are most commonly offered on loan products because borrowing to invest increases your investment risk. In the current climate, investors may find this increased risk to be unacceptable and look at guaranteed loan products to provide some security. This can be a sound strategy, but often what investors don’t realise is that a guarantee doesn’t make a bad investment a good one — it just controls the potential losses,” she says.

“Guarantees don’t mean that your investments will perform well or be less volatile. They just guarantee that if your investments go bad and stay bad that you won’t also have a debt outstanding at the end of the term. It can also mean that your capital will not go backwards. That may sound attractive, but don’t make the mistake of thinking it hasn’t cost you anything. You’ll still have to pay higher interest costs over the term of the loan.”

The warning comes as a number of product providers, including the likes of Macquarie Bank, look to capital guaranteed products in order to cater to the increasingly cautious tastes of many jittery share market investors.

Earlier this month, Macquarie released two new capital protected investment products, Capital Plus and Deposit Plus.

Macquarie equity markets division executive director Jeff Weedon is quick to acknowledge the launch of the products was opportunistic to take advantage of negative share market sentiment, but says criticism of capital guaranteed investments is unfounded.

He says capital guaranteed investments serve a specific purpose to a very particular type of investor — those who value capital preservation above all else, especially soon-to-be retirees.

“[These products] are right for anyone who is absolutely concerned about capital preservation, but also understands the value of equity market exposure,” Weedon says.

“It is all well and good to postulate about good investment returns, but if you are someone who has to preserve capital it is only academic because your absolute priority is to preserve capital.”

Biti does not necessarily disagree. But she says the message to investors from their advisers should be that they should not choose a product only because it includes a guarantee.

“We use guarantees a lot of the times for different clients, but you have to assess whether that strategy is viable for clients,” Biti says.

“Some people may overlook all other investment fundamentals and just go for the guarantee. They should realistically understand what they are getting into.”