Laura Slattery takes a look at the tracker bond and its advantages or otherwise for investors

After three years of zig-zagging graphs illustrating each hopeful surge and despairing slump on a turbulent market, it's little wonder that whole suites of tracker bonds are being sold on the back of a guarantee.

In financial advertising, "guaranteed" is a magic word, automatically triggering feelings of comfort and reassurance.

Investors might not know exactly how much they will get back from their investment, but they know that at least they will get their money back - minus whatever amount inflation has eaten out of it in the duration, of course.

The problem is very few trackers guarantee to give investors anything more.

If you thought trackers were a type of mortgage, sniffer dog or cereal bar, then bank and insurance company brochures promising that trackers will offer "the best of both worlds" (New Ireland) and will "squeeze the most from your money" (ACCBank) may come as something of a surprise.

Tracker bonds typically guarantee to protect the initial capital, placing some of the investment in a fixed-rate deposit account to generate this guarantee, while exposing the rest of investors' savings to the equity market.

The market has opened up in recent years to smaller savers with minimum investment requirements as low as €2,000.

There are a number of varieties on sale. Some combine a five- or six-year bond with a fixed-rate deposit account offering a high rate of interest on part of the investment for the first year or two of the product.

Others market the fact that they invest in blue-chip or household name companies rather than simply tracking a handful of indices.

Seemingly generous limits on maximum returns, 100 per cent participation rates, investment term options, final year averaging, early incentives and lock-in features may also be part of a bond's design.

"As a rule of thumb, avoid the particularly complicated ones," advises Mr Liam Ferguson of Ferguson & Associates. "For most consumers, simple is good. The tracker bonds I would favour would be the ones that simply offer the capital guarantee - or ones that offer a little bit more than a capital guarantee, although those are beginning to die out - and a straightforward participation in an index or a combination of indices," he says.

The return on tracker bonds should stave off the eroding effects of inflation. But, with terms of up to six years common and current inflation rates running over 4 per cent, investors could well lose out in real terms if recovery in the market fails to materialise. And, without any early encashment facility, they could be powerless to stop the bleed.

Even if a protracted recovery starts to take shape and indices rise, tracker bonds often hide charges and caveats that eat into investors' net gains.

One financial consultant told The Irish Times he advised clients not to invest in trackers because of the way the costs were skewed toward the providers of the bond.

"The provider is not going to lose because they're making money on the cost of the options," he said.

Cautious savers could simply avail of the best fixed-interest deposit account in the market, Anglo Irish Bank's seven-day notice account, notes Mr John Lowe of Providence Finance Services. This account currently pays 2.75 per cent on amounts over €2,000.

Trackers are useful in the context of diversifying a portfolio, Mr Lowe believes, but they are not for people's life savings.

Meanwhile, experienced investors will probably decide that they would be better off taking more direct bets on the market.

"Nobody should ever go into a tracker bond thinking that they will get stock market returns. That's the big mis-sell," says Mr Ferguson.

"Provided you are happy that you will have no access to your money, you may get a marginally better return than a fixed-rate deposit, but no matter what the marketing blurb says, if there's annual growth of 15 per cent on the index, don't think that you will get that."

There are two ways to limit the upside on tracker bonds. One is to offer investors less than full participation in the growth of the indices or company share values being tracked.

The other way is to offer a 100 per cent participation rate but limit the maximum return on a basket of shares to, say, 40 per cent.

If you think that markets will rise by more than this amount over the full term of the bond, then you will miss out by investing in the tracker. On the other hand, if you doubt that the markets will rise by anything near this amount, then a 40 per cent limit will seem irrelevant.

On closer inspection it may transpire that the 40 per cent cap does not just apply to the overall return, but to each individual share. This will effectively drag down the average return on the shares and hence the overall return on the bond. "You could nearly call it financial sleight of hand," says Mr Ferguson.

This ploy is common to the market and of the trackers currently available on the market, the First Active Combination Bond is one example of where it is used.

The maximum return is advertised as 55 per cent gross, but it is further noted that the gain on each of the 50 shares it tracks is capped at 55 per cent.

Winning shares reaching 80 per cent growth won't be allowed to compensate for those that rise by just 30 per cent, so to get the maximum return, all the shares would have to grow by 55 per cent or more.

The same rule applies to the Friends First bond. A lock-in feature means gains of 50 per cent can be secured at any time during the term, protecting investors from subsequent losses, but it also means any growth higher than this on individual shares won't be counted.

Another criticism of trackers is the fact that they don't distribute dividends. Canada Life has recently reintroduced this feature to the bond market through its Dividend Bond.

"You would certainly have to read between the lines and read the conditions very carefully," says Mr Lowe, but it is a welcome innovation nonetheless, he believes.

Averaging of values over the final year or six months is one feature that is often sold as being attractive, but it is a "double-edged sword", warns Mr Ferguson.

"It's portrayed as being a safety feature and as an advantage to the product almost, so that if there's a big drop in the final year, you are shielded from the worst effects of it," he says.

"The inverse is also true. It reduces the possibility of gaining from a big spike near the end of the investment."

Single premium investment business is down across the sector, insurance companies say, but tracker bonds are far from being the worst hit.

Financial advisers argue that trackers are often a bad compromise between deposits and equity, but as long as cuts in annual bonuses make with-profit bonds seem precarious for cautious investors, a flurry of tracker bonds seems set to be released in an attempt to attract low-risk investors.