New generation capital protected fund

Capital guaranteed investments have in the past been popular with New Zealand investors because of the security they offered. However, the old style products have, over the years, tended to fall from grace because the trade off between safety and returns was too great.

IPAC Securities general manager David van Schaardenburg says the old capital guaranteed funds developed after the 1987 sharemarket crash as people were worried about capital losses.

Part of the problem with these types of funds was that they tended to invest in assets which had little downside risk, and the manager was charging high than average management fee for that type of asset.

"After a while people tended to see through them," he says.

While there are still some of these older style products around, there is a new generation of capital guaranteed fund being offered to the public.

The latest range of these types of products have addressed the former problems by investing in higher risk assets and using strategies to remove risks from the equation.

The most active player in this market over recent has been Ord Minnett with its Australian-domiciled OM-IP series of managed funds.

While no exact figures are publicly available about how money has been raised in by Ords in New Zealand, it is known the funds have been popular.

The basis of these funds is that a set percentage of the initial investment money is put into a zero coupon bond which guarantees there will be sufficient funds at maturity to repay the capital. The balance of the funds is farmed out amongst a number of managers who invest in futures, commodities and currencies.

The Bank of New Zealand has now entered this market with a new investment which has similar characteristics but is quite different in nature.

BNZ's Capital Protected Index Investment (BNZ CPII) is a term deposit, as opposed to a fund, which produces returns linked to the performance of the S&P 500 index in the United States.

One of the beauties of this product, compared to the OM-IP series, is that although it works in a similar way it is far simpler in its presentation. For instance Ords provided volumes of information about its funds and how they work, while BNZ's investment statement and marketing material is brief and devoid of detail.

BNZ Wholesale Financial Services head of advisory services Laetitia Peterson says a portion of the initial investment money is put into zero coupon bonds which will provide an adequate return to ensure the bank can pay meet the capital guarantee. The balance of the funds are invested in derivatives.

"The beauty of what we do is that we don't have to explain derivates to the customers," she says.

Investors in the CPII are paid a variable interest rate on their term deposit which is linked to the monthly average performance of the S&P 500. Peterson says the total return for the two-year term is capped at 30%.

Peterson says describes the CPII as being like a convertible bond in that it is protected from downside risk, yet has upside potential and an equity kicker.

"(The CPII is) like a cash or debt instrument, but with equity characteristics."

Peterson says these sorts of products are very popular overseas, and BNZ related banks in the United Kingdom have recently launched a series of similar products linked to other indices including the FTSE.

She says the CPII was developed as New Zealand investors were asking for more innovative products.

Other key features of the CPII are that:

• It is fully hedged to the New Zealand dollar, so investors don't have to worry about potential losses if the Kiwi starts to fly.

• Because the BNZ CPII is a term deposit there are no fees to pay, while other similar products delivered as managed funds do have up front fees.

• It is for a two-year term running through to November 15 2002, while the OM-IP funds are generally for about eight years.

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