Capital Protected Investments and Guaranteed Equity Bonds

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This type of investment is designed to offer a degree of  protection to capital (e.g. 75%, 90%, 100%,) whilst offering the potential for higher returns. The more risk to capital, the higher the potential return (includes "precipice" bonds below). The return will be linked to a basket of quoted shares, or a stock market index  (or a basket of indices), and the  most popular is the FTSE 100 index. The term is normally fixed for five or six years, sometimes with an option of the seller to close the bond and repay capital plus income early under certain circumstances (a "kick-out" clause).

Currently, some plans offer more than 100% of the upside movement in the index (e.g. 120% to 150%) whilst still offering 100% protection of capital. In cases where less than 100% capital is protected, the potential return should be more than the movement on the basket of shares / index.   

In some cases the vendor, typically a high street bank or insurance company, will guarantee the capital itself. In other cases, the protection is obtained by the vendor purchasing financial instruments from city institutions such as merchant banks. In this case, there is some risk to the protection of capital, since it is  dependent to a greater or lesser degree upon those financial institutions meeting their future obligations.

The investments should be considered fixed-term. Most can be broken and capital withdrawn, but the penalties for doing so are unattractive.

Taxation: Can be subject to income tax or capital gains tax depending upon the  structure of the investment. 

"Precipice" Bonds

The recipient of much media attention and claims of mis-selling in the past, the precipice bond was a form of capital protected investment where capital was protected provided a given base level of the index or basket of shares was not breached. Below that base level, the capital protection was extinguished and investors stood to lose capital. 

Otherwise, the investor enjoyed high levels of interest during the term of the bond.

The potential loss of capital could be a multiple of the fall in the index: e.g. for a 1% fall in the index 3% of capital would be lost. 

Provided the index or basket of shares did not fall below a point, or ended the fixed term at a certain level or above, then 100% of capital would be returned. But if it fell "over the edge" (hence the term "precipice"), then  the investor was in trouble.

The main cause of dissatisfaction with these products was not their design, but the manner in which they were sold. In some cases the investor believed the investment to be lower risk than it really was. 

Guaranteed Bonds

Offered by insurance companies, and often sharing features with protected investments and precipice bonds, the typical guaranteed bond has a fixed rate of return (i.e. not usually based upon equity markets) and a guaranteed level of capital repayment. The term is usually between one and five years. 

Income bonds pay regular income: growth bonds pay all interest  at maturity of the bond.

Higher rates of interest may be obtained by adding some degree of risk to capital. 

Taxation: These bonds are taxed at source and this is deemed equivalent to basic rate tax. Non-taxpayers and lower-rate taxpayers cannot usually reclaim the excess tax.

What you will get back depends on how your investment grows. The value of the investment can fall as well as rise. You should remember that past performance is not necessarily a guide to future returns.