You can invest in a wide variety of different assets from within an investment bond. Investment bonds offer access to collective investment funds covering a wide range of different risk ratings and investment styles. With collective funds, your money is pooled together with other investor’s money so that a broad portfolio of assets can be invested in and are actively managed on your behalf. The choice of funds is enormous, with funds that invest in different countries, regions and industries – as well as different types of bonds and shares. Exposure to risk can be reduced by spreading the risk across different sectors, asset categories and geographical location. By achieving greater diversification, it is possible to reduce the overall vulnerability of a portfolio.
Cash or deposit funds are available within onshore and offshore investment bonds. This area is ideal for short-term savings where access is required at short notice, and flexibility is the most important issue. Everybody should maintain a reasonable sum in deposit accounts for emergency purposes if nothing else.
They are often regarded as low risk, but they are by no means risk-free. The disadvantage of this area is that the interest paid is not very high and over the longer term has struggled to even match inflation. Inflation reduces the purchasing power of cash as it increases the value of goods and services over time. This means that the real value of investments held in cash funds could decrease over time. There is also the “opportunity cost” of not being invested in other types of investment – you lose the opportunity to potentially receive more elsewhere. The disadvantage of this area is that the interest paid is not very high and over the longer term has struggled to even match inflation.
Gilts and Corporate Bonds
It is possible to access gilt and corporate bond funds within investment bonds. Gilts are issued by the Government when it needs to borrow money. Since the Government has so far yet to default on repayment, gilts are considered to be lower risk investments. There are different types of gilt which are issued at different points in time and for different terms to redemption. Some gilts are designed to link with inflation- these are called “index linked” gilts.
Many lower risk investors chose to invest in corporate bonds, which similarly to gilts are known as “fixed interest” securities. When investing in corporate bonds you are effectively lending money to a company for a fixed term. In return for your loan, these entities pay a fixed rate of interest, usually at regular periods, and buy back the corporate bond when it matures. The risk is that the company may default and you may not get back all or any of your original investment. There are a variety of factors which affect the price of corporate bonds: interest rates, the credit worthiness of the underlying assets, the term to redemption and inflation.
There is a wide range of risk profiles for gilts and corporate bonds, as the table below shows:
Different Types of Fixed Interest Security
|Relative Risk Rating within sector||Name of sector||Description|
|Higher||High Yield Bonds||Bonds with a rating of BB (S&P) or Ba (Moody's) or below are speculative investments. They are called "High Yield Bonds", or "Junk Bonds" and are considered highly volatile, but can potentially offer more growth. Such bonds are issued by start up companies, companies that have had financial problems or are in a particularly competitive or volatile market and those featuring aggressive financial policies.|
|Medium High||Eurobonds||Eurobonds are international bonds issued by industrial corporations, banks, public sectors and supranational organisations.|
|Medium||Corporate Bonds||Corporate Bonds are debt obligations issued by private or public corporations. Companies use the funds they raise from selling bonds for a variety of purposes, for example expanding the business.|
|Medium Low||Foreign Government Bonds||You can gain access to Government Gilts issued by foreign countries. The risk will depend on the safety of the government issuing the gilts.|
|Lowest||Gilts||Gilts are issued by the UK Government to cover deficits.|
Equities are shares of a company and the investor effectively buys a part of the company and its future profits or losses. Investors receive a share of the company’s profit in the form of a dividend payment- they can also benefit from a future rise in the company’s share price. Nobody can predict the stockmarket and it is wise to choose a diversified portfolio of funds across different sectors. Stock picking individual shares can be challenging and time consuming. The most effective way for most people to invest in the stockmarket is via collective investment schemes, where the decisions as to which shares to buy, sell or hold are made by a Fund Manager. Provided the portfolio is sufficiently diversified, investing in equities may be more suited to someone willing to accept medium or high risk investments.
Within the category “equities”, there are lots of very different types of equity funds which have different characteristics, objectives and risk ratings. For example, there is a “cap spectrum”, which means different sizes of listed companies which, generally speaking, become less volatile and risky as you move up the spectrum from small to medium and up to large cap shares. This is because large companies tend to be less prone to wide fluctuations in value compared to small start-ups. There are also different types of shares which vary according to their income and growth characteristics. For example, income stocks are characterised by established companies which have a history of returning value to shareholders by paying dividends. By contrast, growth stocks tend to return value to shareholders by increases to the capital value of the shares. Profits tend to be re- invested to grow the business rather than being paid out as dividends.
There are also different styles of fund management which focus on different behaviour characteristics of shares. For instance, “value” investing focuses on shares which have been sold off and are trading at lower prices than previously. This can be interpreted by a Fund Manager as a “buying opportunity”, or a “recovery, or special situation”. Other styles of fund management include “growth investing” where a fund manager looks for shares which have been buoyant and invests in order to catch momentum which has built up as the share has increased in value. “Defensive” stocks tend to be in sectors where demand is likely to remain constant, regardless of whether or not there is a recession or economic prosperity. Examples of defensive stocks include utilities and tobacco. There are also “specialist” funds which may invest in particular industry sectors, such as healthcare, pharmaceuticals, telecommunications, natural resources or commercial property.
Many funds are concentrated in a specific geographical area such as North America, the Far East, Europe and Emerging Markets. These are often considered to be inherently more risky than comparable UK Equity funds since whilst the underlying assets themselves may have similar levels of volatility, there are exchange rate fluctuations which add to the risk and can work in your favour, or against you. In geographical regions prone to wide fluctuations in exchange rates, this additional layer of risk can be extremely significant. Nevertheless, diversification across different geographical regions can hedge the overall risk of a portfolio and avoid the assets from being overweight in UK Equities- or “UK centric”. This spreading of risk avoids investing in a small number of individual equities, which is a high risk strategy.
Accessing unit trusts or OEICs via an Investment Bond
These are collective investments whereby your money becomes part of a larger fund that is invested by a fund manager according to the ‘trust deed’. This specifies the primary objectives of the unit trust, together with what sort of investments it can hold and in what proportion.
Unit trusts vary in risk profile from extremely cautious to highly speculative. So it is important to match your risk profile to the type of unit trust you buy. The majority of the underlying investments held by unit trusts will vary in value both up and down on a daily basis according to market conditions. This means that the value of your holding in the unit trust will also vary on a daily basis.
Over the medium to long term unit trusts have consistently outperformed interest rates paid on deposit accounts. You should bear in mind that past performance is not necessarily a guide to future performance.
A unit trust investment should be considered a medium to long term investment and you should aim to hold it for a minimum of five years.
Open Ended Investment Companies (OEICs)
OEICs are similar to unit trusts in most respects although they have a simpler charging structure, specifically no bid-offer spread.