Tracker investments vs 'guaranteed FTSE' accounts

caliston

I did some sums yesterday in a posting on the Post Office savings thread where someone was asking about the PO fiveyear saver, which is an account that offers 7.5% gross on half your money and on the other half pays 50% of increases in the FTSE100 over 5 years. Anyway, to save my calculations getting buried in that thread I'll repost them here with a few amendments. Feel free to find fault, mock, etc...

I wrote:

I don't have experience of the FTSE-linked accounts, but the Motley Fool is quite scathing in many articles about such products generally, particularly since they don't pay dividends which can be quite important. It's also worth being aware that the FTSE100 is a fairly restrictive index in that it only holds big UK companies - if big companies like Vodafone, Shell and Tesco do badly then you lose out.

Note that the PO account pays only 5% on your whole sum until the first FTSE reading is taken on 14th Feb. It's quite subject to volatility: if Feb 14th is a particularly good day on the FTSE100 then the return you make is much less, even if it crashes on 15th.

It offers 7.5% gross on half your money - that's a reasonable return. But 50% of FTSE100 growth isn't great, particularly as you don't receive dividends. Without dividends the FTSE100 has gone up from 4000 to about 6500 in the last 5 years (a particularly good period). That's an increase of 62.5% or 10.2% per year. So you'd get 31.3% or 5.6%pa. (Remember we're compounding - also note that small differences in rate can be a big deal in the long term). Thus total return on both halves = (5.6%+7.5%)/2 = 6.55%

But if you had invested in a UK equity (shares) tracker fund (which attempts to do roughly the same job) then growth was from 82% to 167% (see the table of funds sorted by return over the last 5 years). That's 12.7% to 21.7% growth pa. In the better performing funds dividends are usually reinvested.

But this has been a long run of good market conditions. Taking the period over the dotcot crash 1999-2004 and the best and worst UK equity tracker funds (excluding a few outliers):
LEGAL & GENERAL (ex A&L) UK 100 INDEX E: 2002-7 growth 82%=12.7%pa, 1999-2004 growth -26%=loss of 4.7%pa
F&C FTSE All-Share Tracker Fund 1 Acc: 2002-7 growth 108%=15.8%pa, 1999-2004 growth -22.6%=loss of 4.15%pa
But in the same time the FTSE100 went from about 6000 to about 4500 (I'm reading this off a tiny little chart so could be a bit out), so the PO bond would pay out nothing for the FTSE100 bit and thus a growth of 3.75%pa overall.

I would have picked 1997-2002 for the downturn period but the L&G fund only started in 99. The L&G is a fairly lame former bank fund - usually it's best to steer well clear.

At the end of the day it depends what you want really. If you absolutely cannot afford to lose money, I'd recommend a savings account since at least your money will do slightly better than inflation. If you make only 3.75% on the PO bond because the market went down then you've probably just about kept pace with inflation. But with a shares investment there is the risk it may go down, but it's less likely over the long term (5 years+) - see this Motley Fool article. On the other hand you have control over your funds - if the market looks like it's going belly-up, or you need cash at short notice, then you can cash in your investment at the current value.

Of course once you've started going down the investment route there may be other options (such as actively managed funds) that may beat the tracker, with varying degrees of risk. Read some of the investment threads here for more details.

One other thought: both halves of the PO account will be subject to income tax if you're a taxpayer. But you can use the mini stocks and shares part of your ISA allowance for this year (up to £4K) to invest in a tracker and have returns tax free.

caliston

One thing I forgot to add - the trackers have Annual Management Charges between about 0.3% and 1% per annum, which I forgot to take into account in the calculations above.

jon3001

caliston wrote: »

But this has been a long run of good market conditions. Taking the period over the dotcot crash 1999-2004 and the best and worst UK equity tracker funds (excluding a few outliers):
LEGAL & GENERAL (ex A&L) UK 100 INDEX E: 2002-7 growth 82%=12.7%pa, 1999-2004 growth -26%=loss of 4.7%pa
F&C FTSE All-Share Tracker Fund 1 Acc: 2002-7 growth 108%=15.8%pa, 1999-2004 growth -22.6%=loss of 4.15%pa
But in the same time the FTSE100 went from about 6000 to about 4500 (I'm reading this off a tiny little chart so could be a bit out), so the PO bond would pay out nothing for the FTSE100 bit and thus a growth of 3.75%pa overall.

I would have picked 1997-2002 for the downturn period but the L&G fund only started in 99. The L&G is a fairly lame former bank fund - usually it's best to steer well clear.

Best and the worst? On what basis? Did they track the index or didn't they?

I can understand an argument that the FTSE 100 index isn't an ideal one to track. But if a fund manages to track it then it did a good job.

There are various indexes (or indices if you like) on that list: FTSE 100, 250, 350, All-Share. How can you say a FTSE 100 tracker is bad because it was outperformed by a FTSE All-Share tracker?

caliston

jon3001 wrote: »

Best and the worst? On what basis? Did they track the index or didn't they?

I took the table sorted by 5-year performance that I linked to and pick the top and bottom of the cluster (there were a few that haven't been around that long, and one HSBC FTSE250 tracker that was miles off the top for some reason so I avoided those for my picking, though that was where the 21.7% figure I quoted initially came from. A better figure would be the 15.8%).

I can understand an argument that the FTSE 100 index isn't an ideal one to track. But if a fund manages to track it then it did a good job.

That wasn't the question I was answering - the question was: what do you think of this bank account that claims to track the index without any losses? There isn't really much water between funds that track different indices on the scale we're comparing with the bank account. And generally such accounts don't give you an option as to which index is involved (other than go to another bank). Of course past performance is no guide for specific funds, but what I'm trying to demonstrate is what happens in a bull market and a bear market over the spread of funds.

Just to be clear, I'm not commenting at all on the technicalities of index tracking. But I wanted to make clear the difference between stocks and shares tracking and bank-based 'pseudo-tracking' where you don't own any shares but the bank pretends you do out of the goodness of its heart.

munk

I wanted to make clear the difference between stocks and shares tracking and bank-based 'pseudo-tracking' where you don't own any shares but the bank pretends you do out of the goodness of its heart.

Of course this is exactly how the bank's etc market these guaranteed equity bonds (gebs), giving a hint of excitement/thrill to people who otherwise wouldn't want to risk dabbling in the stockmarket but also with a guarantee that they won't lose the house at the same time. 'Everyone's a winner!!!*' says the marketing spiel, although if you read the small print: '* - but we win more on this one to be honest!!!'... if only

My reason for being cynical is unfortunately closer to home having seen how banks can get away with murder selling gebs to vulnerable elderly people who have little or no financial knowledge at a premium rate (6.6% initial charge in the case of Scottish Widows with paltry returns of between 10-35% over 5 years! I imagine many people see the 35% and think 'ooh great, 35%pa' not realizing it's only 35% over 5 years). Scandalous IMO - down with direct sellers/tied agents/bank based 'financial advisers'.

Sorry for the vitriol but some of the charges on these gebs and the restrictive potential returns really are like being mugged in the street, albeit in a more sedate and less violent manner(!).

Kudos to you though for trying to do the math so to speak but if you're considering publishing that post as an article I'd suggest you highlight your conclusion in the very first paragraph of the post/article - namely to paraphrase that gebs really aren't worthwhile and you're better off either saving money in a savings account in bear years or in well managed cautious managed funds in bull years.