In volatile times, wise investors plump for protected funds

The stock markets are unsettled, and again talk of protection is in the air. The idea of exposure to the opportunity for equity market growth, without danger to one's original capital, sounds an attractive one - particularly for the many cautious investors looking for relatively low-risk stock market opportunities, not to mention those people who have never taken the plunge into equities.

The stock markets are unsettled, and again talk of protection is in the air. The idea of exposure to the opportunity for equity market growth, without danger to one's original capital, sounds an attractive one - particularly for the many cautious investors looking for relatively low-risk stock market opportunities, not to mention those people who have never taken the plunge into equities.

And with the opportunity to tuck the whole thing away from the taxman in an Isa wrapper, those protected returns are even more secure.

The basic principle of most protected equity investments is that the bulk of investors' money goes into stocks, with a small amount being channelled into complicated instruments called derivatives which are used to protect the investment's value if the market falls below a certain level.

But you'll pay a price for protection, in the shape of limited benefits from any stock market growth during the term of the investment. With some products the proportion of growth is specified at the outset, so you'll know the maximum you could earn. It can sound substantial - so remember that's over the full three- or five-year term.

Unlike ordinary unit trust Isas, protected Isas generally run for a fixed time, typically three to five years. That means once they have matured, that chunk of tax-free stock market exposure comes to an end, which makes them more attractive to investors working to a timescale of a few years rather than decades.

If you have a limited timescale - if you're coming up to retirement and cannot afford to put your precious capital on the line, but don't want to lose out altogether on stock market performance - the sacrifice of an element of growth potential in return for capital protection could be well worth paying.

But if you can afford to take a longer perspective your money is probably better off in an unprotected Isa where it can benefit to the full from stock market growth. Jason Hollands of IFA Best Investment says: "For most investors with a long-term view, the additional restrictions are not worth it, because over five years or so your investment is more than likely to recover from any market downturn."

Still, risk-averse investors who want a guaranteed level of security of capital (not necessarily 100 per cent) have a small but growing range of protected Isas from which to choose, as volatility undermines the allure of the markets.

M&G launched its first protected equity Isa at the beginning of April, offering full protection of investors' capital, plus 80 per cent of any growth in the FTSE 100 index over the five-year term. The offer closes on 19 May, and the full £7,000 Isa allowance can be invested.

Obviously it's unwise to extrapolate from the past when looking into the future, but £1,000 invested in the FTSE 100 five years ago would have grown to £2,100 by March 2000. Under M&G's 80 per cent stipulation, you would stand to make £800 on your £1,000 investment, amounting to 16 per cent growth pa, free of tax.

That's respectable in comparison with a typical building society deposit account, which would have provided comparable security but grown to only £1,230 over the five years or by less than 5 per cent pa (with tax reducing it further).

Abbey National's Safety Plus Isa is interesting. It launched in March and sold out within a week, but the company plans a similar product for release in June. Safety Plus offered full capital protection and a minimum of 20 per cent growth over the five years (amounting to 4 per cent pa). If the FTSE 100 grows by at least 12 per cent per year that will be reflected in investors' returns. But final returns are capped at 60 per cent of initial investment.

A new protected technology Isa just launched by HSBC is available until 1 June. The snazzily titled Safety.net Isa is a three-year investment offering investors 100 per cent of the growth enjoyed by a basket of 20 major global technology stocks, including the likes of Vodafone, AOL, AT&T and Cisco Systems - but averaging the quarterly returns over the term to reduce the inherent volatility of this investment.

Your capital is protected to 90 per cent, so it's not ideal for anyone totally risk-averse. But as a relatively low-risk route into the thrills and spills of the technology sector it's an interesting proposition. Again, up to £7,000 can be invested as a maxi-Isa.

These new investments join a handful of existing protected equity Isas. For example, Bristol & West's maxi-Isa investing in its Guaranteed Equity Bond is a 100 per cent capital guaranteed product with a five-year term. It's linked to the average increase in three international stock markets, the FTSE 100, S&P 500 and Nikkei 225. The downside is that you're limited to a maximum total return of 50 per cent of your investment, an annual average of 10 per cent. One attraction for longer-term investors is that when the equity Isa matures it can be held on the bank's reasonably competitive cash Isa terms.

Other Isable products offering capital protection in return for a limited upside include protected unit trusts. These are index tracker funds; the fund manager uses derivatives to set a "floor price" below which the fund's value cannot fall, and periodically "locks in" gains in the stock market by raising the floor price.

So there is no guarantee on capital value or levels of growth, but an element of protection from a market crash. Among those available are Deutsche's AllWeather Equity Growth fund and NatWest's Safeguard. Lipper statistics to the beginning of March show all are worth less now than a year ago.

Another alternative is to put your money into a guaranteed equity bond, of which there are 15. These are not tax-free, but they do offer the combination of a fixed term, a capital guarantee and stock market-linked growth up to a pre-set maximum level. Bristol &West, Birmingham Midshires, HSBC and Standard Life are among the providers.