Protecting the nest egg

Conventional wisdom has it that low risk and high returns are mutually exclusive qualities in an investment opportunity. Capital protected investment products challenge that thinking, in that they offer the investor the chance to access potentially high returns while at the same time guaranteeing the original nest egg invested. The products return the amount invested no matter what, but also offer a reasonable chance of exceptional dividends. The catch? It's an all-or-nothing proposition.

While capital protected investments can be reasonably sophisticated products, the basic concept generally involves three elements:

1. You invest for a fixed term - anything from three to five years (or even longer);

2. The returns are generated by exposing a portion of the fund to areas where there is potential for high returns such as international share markets;

3. The value of your initial investment is protected, so that even if the anticipated returns do not eventuate your initial investment is returned to you at maturity.

The capital sum is protected in the way these deals are structured.

Each fund will hold deposits with a substantial bank, generally a big international bank with a strong credit rating from a reputable agency such as Standard & Poor's or Moody's. As with any fixed term deposit, the bank will return the money with interest at the end of the term. This enables the fund manager to repay the investor's original sum.

The funds not deposited in the bank are used to earn the potential return. The fund manager will invest them in ways that can produce high end returns such as shares, options, emerging markets, futures or commodities. This portion of the fund can be exposed in relatively high risk (and potentially high return) areas without compromising the capital protection promise.

Hanover Finance's new Global Growth Fund is a local example of the product. The fund is for a fixed term of five years with a minimum investment of $5000. The fund invests in structured notes with Deutsche Bank, to provide the capital protection. It offers a potential return of 10 per cent for each year invested - so that's a possible 50 per cent return over the term of the investment. This return is linked to the performance of a basket of global indices. However, if on maturity of the fund that basket of indices is returning less than 10 per cent, the investor gets nothing except their original capital sum. So while your original sum may be protected, there is also a chance you will earn nothing on your investment. Conversely you could earn a whopping 50 per cent return.

In general terms, capital protected investments are likely to appeal to risk-adverse investors who also want the chance of potentially high returns. Investors need to be in a position to invest for a medium term such as five years, without needing access to the capital or requiring a regular income from their investment.

Next week

Women live longer, earn less and save less for retirement than men. Financial adviser Liz Koh discusses the implications for women.

Send your queries to Money Editor, Herald on Sunday, PO Box 32, Auckland, or email maria.slade@heraldonsunday.co.nz