Another crummy guaranteed equity bond from NS&I

I don’t like guaranteed equity bonds (GEBs). I’ve written before that such structured products are risky, opaque, and often bad performers.

We can also add ‘mean’ to the list, with the launch of the latest UK Government backed GEB.

The 18th Issue GEB from National Savings and Investments is offering 40% of the gain in the FTSE 100 over the next five years, in exchange for 100% capital protection.

According to the NS&I website:

If the averaged index end level is 20% greater than the averaged index start level at the end of the 5-year term, £10,000 invested would earn a gross return of £2,000 at the end of the term. If the index end level was 45% greater than the index start level at the end of the term, £10,000 invested would earn a gross return of £4,000, because the maximum return is 40%.

Okay, relatively simple for one of these often hideously complicated products.

What’s good about this bond?

Firstly, it’s 100% backed by the UK Government. This makes it infinitely safer than comparable GEBs from private companies, which are vulnerable to the companies involved going bust.

Secondly, the gain is averaged by comparing the starting level of the FTSE 100 index (averaged over the first five days) to the end level (averaged over the final six months).

This means you won’t suddenly see your investment collapse in value due to a crash; it also means the last six months of your gains are limited, too.

Thirdly, the return compares quite well with other GEBs from the likes of Barclays and Morgan Stanley, which are also capping returns at around the 40% mark.

You want a fourth? Er, you can invest in it via the post. Handy if you’re getting square eyes from looking at the Internet all day.

Why GEBs like this are a terrible deal

First and foremost, dividends aren’t included.

The FTSE 100 is yielding around 5% at present, so that’s up to 5% a year growth compounded that you’ll be missing out on – something like a 28% return, all things being equal.

Secondly, the 40% cap on gains means you’re being offered a limited reward for the risk of getting nothing.

I’m bullish on the market right now, but I certainly accept the index could be flat or lower over the next five years. If this happens, GEB investors will get nothing for locking their money away for five years.

Indeed, according to the Daily Mail this is what is happening to NS&I GEB investors of five years ago:

Risk-shy saver Michael Barnet, 48, has a five-year NS&I Geb maturing in November. ‘I will probably get nothing but my original money,’ says Michael, who works with Age Concern, ‘but there’s still a chance of a return. When it matures I’ll be tempted to invest in another Geb from NS&I.’

But Michael, from Welwyn Garden City, Hertfordshire, insists: ‘I only save where I know my capital is safe.’

Personally, I’m happy to risk money in the market because I believe the potential rewards are worth it.

The most bullish readings of past data suggest shares could rise 20% a year from here for a decade. I don’t bank on that, but the potential for such rewards is adequate compensation for the risks of market exposure.

Imagine how rotten you’d feel if you invested in this GEB and the market rose even 50% over five years? That rise would only take us back to where we were before the recent crash, but it would be a 75% gain for tracker investors who would also get dividends. In contrast, GEB investors would see barely half of that.

If the market doubled GEB investors would probably go on the rampage. I can almost hear angry housewives phoning Radio 4 in disgust.

Finally, the GEB is hideously illiquid. There is no access to the funds invested once the term has started (unless you die, which would be bittersweet to say the least).

In contrast, you’re free to sell out of shares held in say an index tracker fund whenever you want, for whatever reason you want.

What you should really do if you’re nervous

If you’re very nervous about the stock market or need your money within five years, you should probably be in cash, not shares.

I’d consider it a decent wager that you’ll make half of the GEB’s 40% maximum upside by rolling your money through the best 12-month fixed rate savings bonds for five years, with zero risk of getting no gains at all.

I know saving interest rates are low at the moment, but I don’t see that lasting forever.

Alternatively, you could keep say 75% of the money in cash and say 25% in an index tracker. The cash would grow through interest, and you’d get dividends and potentially a capital gain from the tracker.

Remember, assuming FTSE 100 dividends hold from here, the market would need to fall 20% or so fall for you to lose out on the tracker, provided you reinvested your dividends every year. Plus you have interest on the cash providing a further cushion.

I’m sure someone nerdier than me could calculate the perfect tracker / savings / GEB combination for most market eventualities. But I’m not just being lazy – it’s all far too much complication for anyone, which is the ultimate black mark against these silly products.

If you must have a GEB, the NS&I one at least has the Government guarantee. And as I say, the capped gain looks competitive compared to others – I’d expected to find more compelling alternatives.

But GEBs still won’t see a penny of my money.

Remember: I am not a financial advisor. Consult one if you need to. This page does not constitute financial advice of any sort.