Inflation running at more than double the 2% target set by the Bank of England would normally signal the need for an urgent rise in interest rates.
But with growth in the economy still very weak, it is unlikely that the Monetary Policy Committee will risk bringing that to a standstill by raising rates in the near future.
Any decision to keep interest rates on hold is, of course, likely to impact on those with savings to invest. Anyone looking for a decent return on capital is now being forced to consider alternatives to deposit accounts. But many such alternatives come with significantly increased levels of investment risk, which does not suit everybody.
One investment that offers the potential for much improved investment returns and capital protection up to a point, is the FTSE 100 enhanced kick-out plan offered (in tranches) by Investec Structured Products.
The simple objective of the plan is to deliver a high return on capital for each year that it is in force. The most recent tranche offered a potential return of up to 10.75% p.a.
How it works
The level of the FTSE 100 Index at close of business on the plan start date is recorded, and this will be the initial index level.
On each successive anniversary for the next four years, the closing level (averaged over five working days) of the index will be recorded again. If that level is higher than the initial index level, even if by only a single point, the plan will mature and pay out your original investment plus the target rate of return for each year it has been invested.
If the plan is still in force at the end of the fifth anniversary, the average level of the index is calculated over the final six months, and if this is higher than the initial index level, you will receive your initial investment plus 120% of the difference between the initial index level and the final averaged level.
So what happens if the FTSE 100 index is not above the initial index level on any of the plan anniversary dates, including the final anniversary?
In that scenario, your capital return will depend on whether the FTSE 100 index has ever fallen by 50% or more during the term of the plan.
Scenario 1 – FTSE 100 index has not fallen by 50% or more
If the index has not fallen by 50% or more from the initial index level at any time during the term of the plan, you would simply receive your initial capital back, with no growth.
Scenario 2 – FTSE 100 index has fallen by 50% or more
If, on the other hand, the index has at any time fallen by 50% or more from the initial index level, and remains below it on the fifth anniversary, your initial investment would be reduced on a one-for-one basis for any percentage fall between the initial index level and the averaged index level on the fifth anniversary.
Thus your initial investment is safe (subject to the continued solvency of the counter-party, as explained later) as long as the index does not fall by 50% or more. As this would require the index to fall to a level of around 3000, and the last time the index was that low was back in January 1995, this seems unlikely.
You will have noted that this plan uses a technique known as ‘averaging’ to calculate the level of the FTSE 100 index on the anniversary dates.
The reason is straightforward – if the early maturity (or indeed the final value on the fifth anniversary) depended on the level of the FTSE 100 index on a specific date, there is a danger that a last-minute fall could have a severe detrimental effect. By taking the average level of the index over a short period, the impact of any last-minute fall is reduced, although clearly if the market is rising, averaging works in reverse and would be detrimental.
While it is possible to withdraw your capital before the plan matures, you are likely to get back less than your original investment, so you should not invest capital you are not prepared to commit for a maximum of five years. Of course, it may be tied up for only 12 months, but that depends on the performance of the FTSE 100 index.
Counter-party risk – how secure is your investment?
This type of investment does not normally provide recourse to the Financial Services Compensation Scheme, so before investing it is important to understand that in the event of the insolvency of the counter-party (which provides the underlying investments), you are likely to lose most or all of your investment.
For this reason, Investec offers two options. With the first option, the counter-party is Investec Bank, and to reflect their lower credit rating, this option offers a potential return of 10.75% p.a. The second option is backed by five of the leading UK banks (HSBC, Barclays, Santander, The Royal Bank of Scotland and Lloyds TSB). The lower risk profile of this option translates into a slightly lower potential return of 9.75% p.a.
Types of investment available
It is possible to invest in this plan in a number of ways. For tax-free returns, it is available as a 2011/12 stocks and shares ISA (maximum investment £10,680), and can also receive transfers from prior year ISAs.
It is possible to invest in the plan directly (maximum £1m). In this case, it is expected that under current tax rules, any investment returns would be potentially liable to capital gains tax rather than income tax, which means you can make use of the annual CGT allowance, a much under-used exemption.
For full details, call Pulse Independent I.F.A.* on 01255 672112, or email firstname.lastname@example.org
*a trading name of R.J. Hurst and Partners Ltd., authorised and regulated by the Financial Services Authority.
Please note that tax concessions are not guaranteed and may change at any time. Their value will depend on your individual circumstances.