Are 'target' fund returns really safe from a slide?

Investors looking for a home for this year's cash Isa allowance should be wary of fund managers' latest wheeze, says David Budworth in The Sunday Times. They have launched funds, called "target" or "cash plus" funds, that claim to offer a better return than bank and building-society accounts (say two to three points above the base rate), but without the risks of the stockmarket. UBS and Nationwide already offer them and DWS, formerly known as Deutsche Asset Management, plans to launch its RateBuster fund in March.

So how do these new accounts work? They are all structured slightly differently, but in the case of the RateBuster fund, DWS will invest the capital in the money markets at six-monthly intervals with a guaranteed return of, say, 5%, says Paul Farrow in The Sunday Telegraph. It then invests this 5% interest in a managed account run by Deutsche Bank, which is in turn invested in currency and interest derivatives in a bid to generate the additional 3% target return. DWS and Deutsche have an agreement whereby Deutsche is liable for any negative returns: if Deutsche loses all the money, then investors will not earn any interest on their initial stake. Any gains made are added to the fund and locked in at the next six-month period. So while the interest' portion is at risk, your capital is safe.

The question then remains: how likely is the fund to hit its target return? There's the rub, says Budworth. The target is just that - a target - not a guarantee. And unlike savings accounts, where your capital is risk-free, with these funds, that isn't always the case. UBS, which, like DWS, uses derivatives to generate returns, claims that its fund is less risky than any conventional equity or bond fund, but doesn't guarantee your capital, for example. Given the returns on offer, is taking any risk worthwhile? UBS aims to return 2.15 points above the Bank of England base rate, or 6.9% if the base rate remains at 4.75%. After charges, the expected return is reduced to just 0.15 points above the base rate, or 4.9%, in the first year. In the following years, charges will cut the return to 1.15 points over base, or 5.9%. This leaves higher-rate taxpayers just £12 better off after five years if they invested £1,000 in the UBS fund rather than Alliance & Leicester's Online Saver account, which pays 5.35% before tax. That's not worth risking your capital for.

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Lastly, the complexity of these funds is already making them a hard sell for independent financial advisers, let alone private investors. Peter Hargreaves at Hargreaves Lansdown says he wants to "dig deep and rattle under the stones" before he recommends the fund to clients. "With derivatives there is always a winner and a loser. If the Deutsche team isn't one of the best, there is a good chance they will be a loser I am petrified that it might not deliver."