Children risk losing out financially if parents pick cash Child Trust Funds over equities. Lindsey Rogerson shows how investing little, but often, can bring growth and protection at the same time.

Bleary-eyed and sleep deprived, the chances are Child Trust Funds (CTFs) aren’t top of most new parents’ to-do list. But with 18 years of growth ahead, taking the time to think through your investment now, could make a big difference to your child’s future finances.

At the moment investing your voucher in a cash CTF - which is essentially a tax-free savings account - may well look like the safest and easiest option. If you look at performance figures over the last 12 months, the average 7% interest rates on cash CTFs look better than the typical 8% loss on the average equity-based stakeholder CTF.

However, it pays to bear in mind that CTFs - like children - are a long-term commitment. For new parents it will be a full 18 years before your child is able to get their hands on the money, while even the oldest recipients of the CTF will have to wait another 12 years.

According to the Building Society Association (BSA) some 3.5 million CTF vouchers have now been issued to UK parents in May 2008. In all, a third of UK children are eligible for one, although only around 2.4 million accounts have been opened - around one quarter of them cash accounts.

The fact that so many parents have opted for cash is beginning to cause concern.

Tony Anderson, a director at The Children’s Mutual, explains: "This is a marathon, not a sprint and one year’s performance shouldn’t be taken in isolation. The important figure to focus on is that since CTFs were launched in April 2005, the stakeholder CTF account is tracking at an average of 7.4% growth a year and that’s a strong return in the current climate.

"This is a long-term savings product and we know that historically, equities have outperformed cash."

Of course no one can say for certain when the current turmoil in global stockmarkets will end. However, a glance at the historical data should give the 618,000 parents investing in cash for their children, food for thought. Pick any 10-year period, over the last 25 years, and shares have always outperformed cash.

Inflation danger

Granted, putting the money into a cash CTF means it will not be exposed to the risk of loss on the stockmarket, but parents should not overlook the corrosive effect of inflation.

Parents with young children could be forgiven for not appreciating the full ravaging effect inflation can have on savings, after a decade of historically low inflation. According to Halifax cash savings were hardest hit during the 1970s.

Due to sky-rocketing inflation, savers in that decade saw positive real rates of return on their cash savings in only two out of the 10 years. The worst year for returns was 1975 when the real rate of return was minus 14.1%.

So far no economist has suggested that inflation will return to double digits, nonetheless this is one lesson from history that’s worth bearing in mind when you’re trying to find a long-term home for your savings. If inflation is running at just 5% for example, £1,000 will be worth £614 after 10 years and £377, in real spending terms, after 20 years.

Anderson adds: "If our CTF had been around 18 years ago and a parent had saved £24 a month from the outset, in addition to the £250 vouchers at birth and age seven, this would have produced £10,800 [as at end March 2008]. This is equivalent to a yield of 6.4% a year when you look at the ‘real-life’ performance of the stockmarket over the past 18 years."

Rocky markets can understandably put parents off investing in equities. However, thanks to a concept known in financial jargon as ‘pound cost averaging’, a degree of market jitters can work in your favour, if you’re making regular mon­thly contributions.

This is because phasing investments, and buying up more ‘units’ when prices are cheaper, means you end up with a larger holding than you would have done had you invested the whole lot in one lump sum.

Miles Bingham, head of savings at Family Investments, explains: "By drip-feeding small regular premiums into the market, parents can sensibly buy units on as many good days as bad days, and over the longer term this will pay off positively."

Equity-exposed CTFs

It’s also worth bearing in mind that the downturn in performance of equity-exposed CTFs is by no means universal. Indeed, figures compiled for Moneywise by research group EJR Wealth reveal that several funds have turned in an impressive performance in the last 12 months, far outstripping that achieved by the cash alternative.

If a parent had put the maximum allowed (£250 voucher, plus £100 a month) into the cash CTF offered by Yorkshire Building Society (which has made regular appearances in best-buy tables over the last three years) then with interest and bonuses it would have been worth £4,132, by the end of March 2008. Alternatively, if parents had put the same sum into F&C’s Pacific Assets Trust it would now be worth over £1,000 more - £5,216.

When it comes to investing in equity-based CTFs, parents have a choice between stakeholder and non-stakeholder funds. Although stakeholder funds are invested in the stockmarket, they still offer parents some security thanks to an in-built lifestyling feature. This means that the money is gradually shifted out of riskier investments and into safer asset classes like cash before your child turns 18.

This locks in growth over the years and ensures a stockmarket tumble in the week before your child’s 18th birthday doesn’t cost them too dear.

Most stakeholder funds are passively managed - that is, they literally hug the index that they are linked to such as the UK’s FTSE All-Share. This means the value of your investment moves in line with the index, so if the market rises the value of your investment also rises and vice versa.

As a result passively managed funds have all clocked up similar performances - between 24.2% (Insight Investment Foundational Growth) and 27.5% (Legal & General UK Index Trust) over three years. The difference is explained by management charges - L&G annual management fee, at 0.5%, is half that of Insight Investment.

While index-tracking funds have recorded around the same performance - although those with higher management charges will increasingly bite into returns in the years ahead - the performance of actively managed CTFs has varied greatly. This is because fund managers have much more freedom over where they invest.

Family Investments, with 500,000 accounts, claims to be the largest provider of stakeholder CTFs, and has seen its fund, managed by New Star Asset Management, return 13.2% over three years.

In contrast the stakeholder notching up the best performance - 35% in three years - is offered by Scottish Friendly Managed Growth and managed by Donald Robertson at Edinburgh-based SVM Asset Management.

Scottish Friendly has offered the SVM-run fund to customers since 1999, through its children’s bond savings plan and so adopted it as its stakeholder option when the fund launched in 2005. Roberston believes that performance has come not only because it’s actively managed - which meant he was able to avoid exposure to banks when the credit crunch hit - but also as a result of its exposure to the so-called BRIC economies of Brazil, Russia, India and China.

The fund is only 45% invested in UK equities, it has 15% in gilts, cash and fixed interest, and the remainder predominately in the BRIC countries as well as companies set to benefit from their development.

Roberston explains: "I think part of the battle in the last year was ensuring that you avoid the minefields rather than picking the good ones, so if you avoided pharmaceuticals, financials and property last year, you have done relatively well and we have very little in any of those sectors. We have overweight positions in resources, oil and gas, telecoms and utilities and those have been relatively defensive."

Non-stakeholder CTFs

However it’s funds in the third type of CTF - non-stakeholder - that have been producing the best returns. These are aimed at parents who want the potentially superior returns available from equities but are looking for more control over the investment. The two main providers are The Children’s Mutual and F&C Asset Management.

As mentioned earlier, the best performing of these funds was Pacific Assets Trust offered by F&C Asset Management. Next best was F&C Private Equity at £4,904 followed by Graphite Enterprise Trust at £4,636.

As the name suggests Pacific Assets, which is managed by Peter Dalgliesh, is focused on finding returns in the Asia-Pacific region excluding Japan and Australasia. The trust is 17% in Hong Kong, 15% each in South Korea and Taiwan, and 14% in China.

Like SVM, performance has benefited from not being exposed to the UK and US in the recent credit-induced turbulence.

Both F&C Private Equity and Graphite are private equity investment trusts. The former invests through funds of funds, predominately in Europe, while the latter uses a mix of direct investment and funds of funds.

For those looking for a fund which invests closer to home, fourth and fifth on the performance list last year were Invesco Smaller Companies and F&C’s UK Select Trust, both of which invest in the UK. While the 110-year-old British Assets Trust, invests in blue chips stocks and related securities with global reach.

Parents who want to select from a wider range of investment funds, or to back individual stocks, can do this with the CTF accounts offered by both The Share Centre and Selftrade. Both groups have customers who have successfully turned the £250 plus the maximum £100 a month contribution into over £6,000 in the last three years.

However, the costs associated with running these types of account mean they are only really suited to parents who are going to be investing substantial sums in the account and have a keen interest in investing.

Choosing the right CTF can be a difficult choice - but the good news is that while your CTF is a long-term investment you aren’t committing yourself to 18 years with the same provider. So if you think you made the wrong choice or the investment outlook alters, you can always switch.

Alternatively, if you are invested in a non-stakeholder account you may want to switch to a lower-risk fund once your child gets closer to 18 to lock in your gains and protect the money from stockmarket falls.

Switching between stakeholder accounts is free, but this may not necessarily be the case with non-stakeholder accounts. F&C, however, does allow parents to switch within its range of funds free of charge twice a year.

Switching is simple - all parents need to do is get in touch with the provider they want to switch to and it will give you all the necessary forms to process the transfer.

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• savings
• Child Trust Funds