Tracker bonds provide comfort blanket for keen yet wary investor

Stock market investors have had a rough time of it lately, with the last couple of weeks alone providing enough evidence to prove that "the value of investments can go down as well as up".

Of course, seasoned investors knows that it's a question of balance: on one hand we realise that stocks and shares follow a rocky road, while on the other we must acknowledge that, despite all the negative odds, they have historically reaped rewards greater than all comparable investment options over the longer term.

The hard part comes in squaring this circle - how can the average consumer ride the equity waves without losing his shirt?

This is where the tracker bond enters the picture. A creature first popularised in the Republic at the beginning of the last decade, tracker bonds bring together the two unlikely elements of equity exposure and security.

It all works in a relatively straightforward manner, at least on the surface. Investors will sign over a lump sum - say €10,000 - and will be guaranteed that some or all of this sum will be restituted to them at the end of the investment term.

Most of this money (say 75 per cent) is placed in a fixed-rate deposit account (or similar product) so that it can earn the interest required to provide the capital guarantee at the end of the investment term.

Once that provision has safely been made, the remainder of the cash is used to purchase an option on a stock market index or range of indices.

It is at this point that the investor's capital begins to "track" a specified basket of shares, and where the long-term potential uplift in investment value will hopefully begin.

Tracking differs from buying in that an investor's capital will never actually be handed over to buy stocks; it will merely be used to buy an option that reflects the performance of a particular index.

Since an index is, by definition, a dynamic entity that constantly reinvents itself (think of Baltimore Technologies losing its place in the FTSE 100), investors gain the advantage of never having their all their eggs the basket.

This, when accompanied by the all-important capital guarantee, means that the tracker-bond investor will be somewhat insulated from the vagaries of the stock market, while also managing to hold some exposure to it.

Needless to say, the lower the capital guarantee, the higher the risk and the potential return will be as there is more money available to track the index or indices. Investors should also be aware that many tracker products impose a ceiling on potential growth.

Tracker bonds have been growing in popularity in the Republic since the beginning of the 1990s, with a range of Irish financial institutions offering tracker options at various times.

Since no two trackers will be exactly the same, it will always be worth comparing different products in order to decide which will best suit your needs.

One of the major downsides of tracker products, according to Mr Alan Morton of fee-based financial adviser, Moneywise, is that "we have no notion of what goes on behind the scenes".

Volatility, Mr Morton warns, does not go away just because a capital guarantee exists. Capital guarantees are, he says, "great for cautious people", but must be balanced against the pre-determined exit date that is a feature of the typical tracker product.