Protected Investments

These protect your initial investment over a fixed term while offering some upside linked to a specific investment index. For example, a plan might offer 80% of FTSE 100 returns over five years while fully protecting your initial investment.

Some plans offer a bigger upside at the expense of some risk to your initial investment, e.g. 120% of FTSE 100 returns over five years plus return of your initial investment if the index doesn't fall by more than 50% during that period. The index used can also vary widely, as well as stock markets you might find plans that offer exposure to property and commodities.

These are unit trusts that typically provide a pre-determined level of capital protection (e.g. 95% or 100%) every quarter while offering some upside linked to an investment index or managed fund.

You'll normally need to hold a protected fund until the end of the quarter to benefit from the protection. Unlike protected plans, the index exposure is rarely stated, so you may have to use past performance as a very general guide.

Long/short funds give managers the ability to benefit from both rising and falling markets. They can buy shares they think will rise in value and ‘short’ shares they think will fall. Shorting shares means a manager can profit when a share's price falls, this is a popular strategy with 'hedge' funds.

Does it work? In practice results are mixed. While there's no doubt that some long/short funds have been successful, history suggests that it's very rare for long/short funds to deliver positive returns in all market conditions.

Unit trust managers have been allowed to use long/short strategies since April 2004, although choice is still thin on the ground.

Constant proportion portfolio insurance (CPPI) funds try to protect your investment by actively managing the split between cash and shares based on a mathematical formula. The idea is that when markets rise money is moved from cash to shares and vice versa when markets fall.

This provides scope for reasonable upside with some downside protection (typically 80% of the fund's highest ever value).

The nuts and bolts of protected plans and funds tend to be similar.

Suppose you invest £100 in a five year plan. The manager invests sufficient in a fixed rate cash account (or similar) to return your £100 at maturity, e.g. £80. The balance (e.g. £20) is used to purchase exposure to the chosen index, typically by using 'call options' (which give the manager the option to buy shares in the index at a date in future).

The amount of index exposure (i.e. call options) the plan can buy depends primarily on three factors:

• Interest Rates - high interest rates mean less cash needs to be invested to return your capital at maturity, leaving more to buy options.
• Market Volatility - volatile markets tend to push up option prices, meaning less upside participation can be purchased.
• Charges - The more a plan takes in charges, the less money available to buy options.

The only real difference re: protected funds is that the timescale is usually a few months rather than years.

Managers 'long' (i.e. buy) shares they think will rise in price and 'short' shares they think will fall in price. 'Shorting' means borrowing a share and then selling it in the hope you can buy it back in future at a lower price before you're due to return it to the lender.

A long/short manager might also try to reduce/remove market risk by 'pairing' shares in the same sectors. For example, suppose company A company B are both high street retailers. The manager thinks A will perform better than B but is worried that the sector could be quite volatile. If he buys A and shorts B then he'll benefit if his hunch that A performs better than B is correct. However, shorting B will also protect him if the sector falls as a whole.

Long/short funds still tend to have some market exposure, i.e. they have more long exposure than short, and returns will ultimately depend on how good the manager is at picking shares.

CPPI funds continuously alter the balance between cash and the risky asset (e.g. shares) according to a set formula, with the aim of protecting fund value. When markets fall the shares exposure is rapidly reduced in favour of cash, so that the likelihood of breaching the maximum agreed loss is near zero.

The formula works by calculating a 'multiplier', which is determined by the volatility of the risky asset, and multiplying that figure by the biggest loss the fund is allowed to make, known as a 'cushion'.

Buying protected investments directly from the provider is normally the worst of all routes. You'll may pay an initial and relatively high annual charges but get no advice or guidance

There's no benefit in taking this route, so avoid.

Fund platforms (or 'supermarkets') are a great idea, you can combine funds from different managers and hold them in one account. This cuts down on masses of paperwork and means you can view all your funds in one place, making it easy to keep track of your portfolio. They usually have a range of useful online investment tools and switching funds is quick, easy and cheap.

Platforms offer lower cost 'clean' fund versions (without sales commisiosns built in) but you'll have to pay an annual fee to teh platform for their services. Nevertheless, costs are still likely to be lower overall in most cases than buying from a fund manager.

Financial advisers tend to use fund platforms these days, so you'll pay the 'clean' fund charge, platform fee and the adviser's fee.

Bear in mind that a fair proportion of financial advisers are not investment experts, so they may recommend inappropriate funds or push funds of funds (which are expensive but make their life easier). There are good ones out there, don't be afraid to shop around until you find one you can trust - and make sure they're independent.

Discount brokers traditionally refunded some sales commission to reduce costs, as they do not provide advice. Given commissions are no longer paid, discount brokers are largely redundant unless they offer their own low cost fund platform or can negotiate discounts from other fund platforms. Most discount brokers will provide a fair amount of fund and investment information, ranging from thinly disguised sales material to genuinely useful comment and research.