Personal Finance: Pity the plight of the old ex-pat investors

`If investors could understand the new financial products, would they invest?'

MY SILENCE last week was not brought about by any lack of subject matter. Instead I was enjoying the considerably better weather in the south of Spain. There, as here, there is much concern over the way in which income from investments has declined.

For the average UK ex-pat the effect has been dramatic. Spain is in Euroland and pre-EMU convergence brought interest rates down with a thump. True, the European Central Bank has moved them up again, but deposit interest is nothing like that to which many people became used.

Investment providers have been inventive in their endeavours to deliver higher returns to a market that is, perhaps, not as well educated as it should be. The situation over there seemed little different to here, with high-yielding corporate bond funds clearly much in demand, not always with positive consequences for investors.

I doubt many fully understand that these high-yielding funds achieve the yield premium over British Government securities by purchasing bonds of a lower quality. Managers will say underlying portfolios are well diversified, with professionals at the helm.

I have no argument with that, but the reality is when interest rates start to tick up, as they have done recently, this end of the market tends to get hit more severely than higher-grade bonds.

But the real trouble is that the underlying investor has little understanding of this. The most vulnerable find themselves seeking those investments that inevitably carried the higher degree of risk. No wonder elderly people, dependent upon their investment income, and seeing their living standards declining with it, are seeking alternatives, ones often beyond their true comprehension.

Take the latest run of derivatives-based products. This is financial engineering on a grand scale, more suited to the trading floors of multi- national banks than the drawing-rooms of little old ladies.

Put simply, an investment product provider will create an investment instrument which invests part of its portfolio in zero dividend bonds, or similar, to guarantee as far as possible the return of the original capital, using the balance to acquire positions in the futures market that will enhance the overall portfolio return.

In particular, there are a number of products within which "put" options are sold against various market indices, thus creating value within the portfolio to distribute as income. The risk, of course, is that the put is "called".

In other words, that the market in question falls and the investment portfolio has to make good losses that might have been incurred by the purchaser of the option.

Confused? Imagine how a retired, 70-something widow feels.

Selling a put option in these circumstances is taking a bet on the market in question not falling. The buyer of the put option is effectively insuring themselves against potential loss.

If the market does go down, they will be paid by the seller. A number of recent products have included option contracts in a variety of markets, including London and Europe. The product designers can say truthfully that these markets have enjoyed robust strength and the life of the option should be sufficient to weather any short-term fluctuations.

But the reality is that if the market concerned falls over the life of the investment, a loss to those who have invested their savings for high yield will result. The risks may be spelt out in the accompanying documentation, but I doubt many will understand the implications.

I am all for the clever use of new financial instruments, but I am concerned that most investors simply do not understand these new products. And if they did, I wonder if they would invest.

Brian Tora is the chairman of the Greig Middleton Investment Strategy Committee