What are they?
Protected investments work in various ways, but their goal is usually the same: allow you to benefit from rising markets while protecting you from market falls. Sounds
great, but in practice some work better than others and you'll almost certainly need to compromise on investment returns when markets are doing well. Nonetheless, when chosen
carefully protected investments can have a role to play in many portfolios.
What types are there?
In general, there are four main types of protected investment:
Protected PlansProtected FundsLong/Short FundsCPPI Funds
These protect your initial investment over a fixed term while offering some upside linked to a specific investment index. For example, a plan might offer 80% of FTSE 100
returns over five years while fully protecting your initial investment.
Some plans offer a bigger upside at the expense of some risk to your initial investment, e.g. 120% of FTSE 100 returns over five years plus return of your initial
investment if the index doesn't fall by more than 50% during that period. The index used can also vary widely, as well as stock markets you might find plans that offer
exposure to property and commodities.
- Provided the plan offers full capital protection you can sleep peacefully at night.
- The level of index exposure offered is sometimes very attractive, even taking into account the lack of income.
- No explicit charges, they're usually built into the investment terms offered.
- Index is often averaged over the final year, protecting you from big falls towards maturity (although this would probably reduce returns in a rising market).
- The indices used rarely include income, so you could lose out on a potentially valuable part of the investment return compared to holding a fund that tracks the index.
- Depending on the level of protection offered, you could still lose money if markets suffer big falls.
- These investments are only as safe as the banks/financial institutions providing the financial wizardry that make these plans work.
- You might not receive interest while you're waiting for the investment to commence (could be several weeks after you invest).
How do they work?
This depends on the type of investment.
Protected Plans/FundsLong/Short FundsCPPI Funds
The nuts and bolts of protected plans and funds tend to be similar.
Suppose you invest £100 in a five year plan. The manager invests sufficient in a fixed rate cash account (or similar) to return your £100 at maturity, e.g. £80. The
balance (e.g. £20) is used to purchase exposure to the chosen index, typically by using 'call options' (which give the manager the option to buy shares in the index at a date in
The amount of index exposure (i.e. call options) the plan can buy depends primarily on three factors:
- Interest Rates - high interest rates mean less cash needs to be invested to return your capital at maturity, leaving more to buy options.
- Market Volatility - volatile markets tend to push up option prices, meaning less upside participation can be purchased.
- Charges - The more a plan takes in charges, the less money available to buy options.
The only real difference re: protected funds is that the timescale is usually a few months rather than years.
Does lack of income make a big difference?
Protected plans and unit trusts rarely include income from underlying investments in the returns you receive. Does this make much of a difference?
The following example compares a typical protected plan with a tracker fund. Let's assume the protected plan offers 120% FTSE 100 participation over five years, the FTSE 100
tracker fund has total annual costs (TER) of 0.3%, the FTSE 100 dividend yield is 3% and the initial investment £10,000.
||FTSE 100 Change over 5 years
Tracker figures assume total return spread evenly over 5 years, dividend based on fund value at beginning of year and reinvested at end of year, annual charge applied at end of year.
Ignores averaging that applies to the final year of many protected plans in practice.
As this example shows, protected plans tend to struggle versus low cost tracker funds in rising markets and during modest falls because, unlike trackers, they don't normally
benefit from dividends.
If you buy a protected plan outside of an Individual Savings Account (ISA) always check whether returns are subject to income tax or capital gains tax (CGT), as this could make
a big difference to your potential tax bill. CGT is usually preferable as you have the potential to offset gains against your annual CGT allowance at maturity. Where returns
are subject to income tax they're usually classed as interest.
Returns from protected unit trusts are normally subject to CGT, while returns from long/short and CPPI funds are taxed as per conventional funds, i.e. gains as CGT and
income as dividends.
How quickly can I get my money back?
Protected, long/short and CPPI unit trusts should be straightforward to sell, allowing you to receive your money within days. However, if you sell a protected unit trust
before the end of the protection period, you won't be protected.
Protected plans cannot normally be sold until maturity. If the provider does let you encash before then you'll probably be charged a penalty for doing so. Don't invest
unless you're confident you can tie up the money until maturity.
How can I buy protected investments?
There's several options.
ProviderFund PlatformFinancial AdviserDiscount Broker
Buying protected investments directly from the provider is normally the worst of all routes. You'll may pay an initial and relatively high annual charges but get no advice or
There's no benefit in taking this route, so avoid.
Here's some of the more common ISA jargon you might come across:
|Call Option||Gives the right to buy an investment at a certain price in future.
|CPPI||Constant Proportion Portfolio Insurance is an investment method that actively manages the split between cash and shares, based on a mathematical formula, with the aim of protecting your money.
|Long / Short Funds||Investment funds that can benefit from both rising and falling markets.
|Protected Funds||Investment funds that typically provide a pre-determined level of capital protection (e.g. 95% or 100%) every quarter while offering some upside linked to an index or managed fund.
|Protected Plans||Investments that run for a fixed term and protect your initial investment while offering some upside linked to a specific investment index.
|Structured Product||A type of investment that is manufactured to try and meet certain risk and return criteria, protected plans are a popular example.