With investors cautious due to the current economic climate, might protected funds be a viable option? Barney McCarthy finds out more

The troubles at Bear Stearns in recent weeks are the latest installment of a credit crisis that seems to just run and run. Stock markets across the globe have slumped and recovered many times over, becoming a volatile and unpredictable place to invest your money. In light of this, you may be looking for a safer way to invest your money.

Protected funds could be a potential option. The Investment Management Association states their aim is “to provide a return of a set amount of capital back to the investor (either explicitly guaranteed or via an investment strategy highly likely to achieve this objective) plus some market upside.”

Richard Ramyar, head of research for Lipper, says protected funds aim to achieve a minimum return, while protecting investors from a maximum pre-defined loss, by putting some funds in relatively safe high-grade assets. “The potential upside is cut because you have less long-term equity exposure, but losses in the worst-case scenario should be less dramatic,” he explains. “They are another option for those concerned about capital loss because of their stage of life or concerns for the economic situation.”    

Roland Kitson, sales and marketing director at Close Investments, says protected funds tick all the boxes in the current climate. “Protected funds meet investors’ requirements for a fund that offers security, liquidity and returns,” he says. “Uncertainty causes different behaviour and people don’t mind bad news so much, they just don’t like a shock. Protected funds allow investors to grow their money without exposure to risk.”

Suits you?

So are protected funds the right option for you? Kitson says that they are suitable for cautious investors considering making changes to their equity portfolios or as an alternative to ‘with profits’ funds. “They can also be used instead of bank or building society cash investments and as an alternative to cautious managed funds,” he says. “The latter aren’t that cautiously managed at all and don’t afford much protection as you can lose unspecified amounts.”

There are a variety of different types of protected funds too. Guaranteed equity bonds are insurance-linked products and offer returns linked to the performance of the FTSE 100 index over a set term. If the index grows over the term, you will benefit from that growth and if it falls, you will still get back 100% of your original investment.

Structured products, another type of protected fund, are designed for investors who wish to combine the potential upside of strong stock market growth with a guarantee that they will get their original investment back. Be careful though, not all structured products are 100% protected. Protected unit trusts are a third type and offer perhaps the greatest integrity and flexibility. They are open ended with no fixed term and allow daily pricing and dealing, with cash type characteristics and liquidity protection.

Not everyone wants to sing the praises of protected funds however. Jason Butler, a qualified investment manager and partner in Bloomsbury Financial Planning, says that when markets are ruled by hope people will buy anything, but that when they are controlled by fear, people forget the fundamentals. “With protected funds, you give up a lot of the return for the protection you receive,” he says. “If you can’t cope with the risk then you shouldn’t invest – there are no get out of jail cards or get rich quick schemes.”  

Slight returns

Ramyar believes protected funds can come to the fore in difficult trading conditions, but warns they are not without risk. “Although the average protected fund on sale in the UK only returned 2.9% over the past year, this compared to the average UK investing equity fund that lost 4.8%,” he says. “The top 10% of protected funds returned between 13.8% and 17.4% over the last year. These figures do show they have a role in times of market stress. Nevertheless, they are not risk free. The worst 10% of protected funds lost between 4% and 7.5% over the last year – better than the worst equity funds, but worse than cash.”

Protected funds are not without their risks, but used realistically may provide shelter from the economic storm.