Fund locks in value to curb investment risk: A new unit trust controls the speed at which holdings can fall

UNIT trusts are not allowed to offer a guaranteed return, but one new fund, the Objective Limited Risk Equity Fund, with a sophisticated cocktail of futures and options, promises that the value of your holding will not fall by more than 5 per cent over any six-month period.

If the market falls by 20 per cent in the first six months, a pounds 10,000 investment in the fund will still be worth pounds 9,500. The value of the units 'locks in' at the end of each period, so if the index doubles in the first six months then halves again in the second six months, the pounds 10,000 will be worth pounds 19,000.

Strategies such as the exotically named 'cap and collar' are used to achieve the effect, but the fund also has an international spread of risk and operates indexed portfolios in each market. The fund should, over the long term, reflect 85 to 90 per cent of the capital-plus- income return of the market index, said Martin Andrew, the marketing director.

The charges are low by unit trust standards, at 4.5 per cent initial and 1 per cent annual. Minimum investment is pounds 2,000.

The fund has been designed to compete with the many 'guaranteed' funds or building society accounts now available, such as the Halifax Guaranteed Equity Bond launched last week. Guaranteed funds aim to reassure the risk-averse investor by promising that the original investment cannot fall in value. In addition, most such investments offer a return that reflects any rise in the stock market index. Most have a fixed term; the guarantee will not be honoured if you cash in early.

These guaranteed investments are complicated and there are at least three areas to watch carefully - the exact terms of the guarantee, the charges and taxation.

Save & Prosper's bond apparently offers very good terms. Over five years and three months, it guarantees to return your original investment if the market falls, and if it rises to return the investment plus 'up to 140 per cent' of FT-SE index growth. No charges are quoted, although in practice a percentage, perhaps 6 or 7 per cent, is taken at the outset to cover costs. The 140 per cent index growth figure is calculated on your net investment (say, 93 per cent of the original) and only applies on market growth of up to 60 per cent. If the market rises by 60 per cent over the term, a pounds 10,000 investment might grow to pounds 17,480.

With the lock-in option, which deducts higher costs and has a lower level of gearing, the same market increase might produce only pounds 14,940.

The Save & Prosper plan is an insurance bond. There is no capital gains tax or basic-rate tax to pay on the gain, although higher-rate taxpayers will face an extra bill and the gain could push a basic-rate taxpayer into the higher rate band, or cause an older investor to lose age allowance. Most bonds of this sort offer a return linked to index growth only - without any reflection of dividends paid or reinvestmentof income. Income can be a very significant part of market return.

Over five years to the end of 1993, in figures calculated by Objective Unit Trust Management, the FT-SE index showed capital growth of 90.64 per cent, but including income this figure rises to 141.8 per cent. A guaranteed bond offering growth only is, therefore, promising a good deal less than the investor could get by investing directly in the market.

Guaranteed accounts offered by building societies are simpler but still have pitfalls. Both the Halifax and Norwich & Peterborough promise investors 100 per cent of capital back at the end of a five-year term. If the market rises you get 100 per cent of the capital increase. If it falls, you get a predetermined rate of interest - equivalent to 4.56 per cent a year from Norwich & Peterborough and less than 3 per cent from the Halifax. There is no lock-in, so your return depends on the index at the end of the term.

Building society bonds are straightforward and will give a good gross return to investors if the market rises, though not as good as if invested directly in the market. The big disadvantage is tax: all the return is liable to income tax in the year of encashment, and a substantial return could affect basic- rate taxpayers and age allowances.

The unit trust structure of the Objective fund wins out in this respect. Assuming it captured 80 per cent of a 50 per cent market rise, the value of a pounds 10,000 investment would go up to pounds 14,000. This gain would be liable to capital gains tax, but falls within an investor's annual exemption. In addition, the investor would have received a small amount of dividend.

In similar circumstances a building society bond would give a gross return of pounds 15,000, but after basic-rate tax this would go down to pounds 13,750. In addition to the tax advantage, the unit trust has clearly stated charges and can be traded at any time.

Although the 5 per cent downside protection only applied strictly to the end of each six-month period, anyone selling within the six months should be exposed to only a 'fractionally' greater fall in value, Mr Andrew said.

----------------------------------------------------------------- Sampling of protected products ----------------------------------------------------------------- Investment Minimum Term Closing Telephone inv pounds years date number Objective Limited Risk 2,000 - - 0277 690400 Halifax Guar Eq Bond 2,000 5 5.4.94 0800 101110 Norwich & P'boro Bond II 2,000 5 19.3.94 0733 391497 Provident Life Escalator 10,000 4.75 31.3.94 0256 470707 Save & Prosper Stockm'kt 5,000 5.25 1.4.94 0800 282101 -----------------------------------------------------------------