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Last year's stockmarket slump has blown such a severe hole in many children's investments that some experts are advising parents to turn their back on stocks and shares, and go for the cash option when choosing a child trust fund.
Investment specialists always go on about how, over the long term, shares have consistently outperformed cash. But recent child trust fund statements have made alarming reading for worried parents - and have been a harsh reminder of that old small-print warning that, with stockmarket-linked investments, "the value can fall as well as rise", with some parents seeing a third wiped off the value of their children's nest-eggs in the past year.
However, other experts argue that while last year was pretty grim, these are long-term investments - so there is plenty of time for the markets to bounce back.
Under the child trust fund (CTF) programme, every baby born after 31 August 2002 receives at least £250 in the form of a voucher from the government to get their account started. Parents, grandparents and others can, between them, put in up to £1,200 a year to help boost the fund's value, and all income and gains are tax-free.
As a parent, you have up to a year to invest the voucher in your choice of CTF. They can choose from savings accounts offered by banks, building societies and others, which pay interest; shares-based accounts, where much, or all, of the money is invested in shares, usually via a unit trust, investment trust or with-profits fund; and "stakeholder" accounts, where people's money is again predominantly invested in shares but the cash is gradually moved into less risky investments, and charges are capped.
Conventional wisdom, and the advice commonly given by independent financial advisers, has been that because shares have historically done better than savings accounts over the longer term, parents are likely to build a bigger nest-egg for their kids over the 18-year investment period by choosing a shares-based or stakeholder CTF.
This advice seems, generally, to have been followed. The latest figures show more than 50% of parents have opted for a stakeholder CTF, compared with 20% for a cash account and 6% for a non-stakeholder shares-based CTF (the rest are doing nothing). And, despite the recent market downturn, many IFAs are still sticking to this view.
"I'd still suggest going down the equities route because of the timescale," says Hugo Shaw of IFA firm Bestinvest, who recommends investment firm F&C's tracker stakeholder CTF as cheap and simple to understand.
Though the downturn means returns for the past four years have been poor on stakeholder child trust funds, as can be seen from the accompanying table, Shaw says this should not put parents off. "These statistics are depressing, but four years is still a relatively short period when it comes to equity investments," he adds.
But not all advisers are backing this view. "I'm not overly keen on stakeholder and equity-based CTFs, full stop," says Roddy Kohn of Bristol-based IFA Kohn Cougar. "I feel the charges are generally too high and the market is quite narrow with accounts offering too limited a choice of funds.
"The marketing is so cleverly done that most consumers are led to believe they are getting value for money when, in my opinion, they are not. And many people are out of their depth when choosing and understanding the underlying funds, so are very disappointed when seeing the recent size of losses on their statements.
"In the current climate, I'd say the vast majority of parents will be better off putting their vouchers and money into cash funds."
Kohn says he has seen cases of clients who have seen 35% wiped off the value of their CTF over the past year. "People need to understand that the volatility and risks are high. If the value has gone down by 35%, then you need 54% growth this year to get back to where you started, and it's unlikely that's going to happen in the next 36 months," he says.
The "best buy" rates on cash CTFs, according to Moneyfacts, include Hanley Economic building society paying 5.5%, Chorley & District building society paying 4.6%, and Yorkshire building society, which is offering 4.5%, a rate that includes a 0.7% bonus for 12 months.
But while rates on some cash accounts are not that impressive, the attraction of these is arguably enhanced when you consider that many people who put money into some of the big-name stakeholder CTFs in 2005 are sitting on losses (see table).
A sum of £250 invested in April 2005 in an average stakeholder CTF was worth only £242 on 8 January this year. But some people have done well. The Children's Mutual offers a non-stakeholder CTF called Baby Bond Choice, where the company has linked up with well-known fund management groups. If you had put your child's cash into its Invesco Perpetual Income fund option, your child's £250 would now be worth around £313.
For more information, visit childtrustfund.gov.uk
Case Study
We're not expecting much from our two small boys' child trust funds - just enough to cover the college fees, first car, deposit on a flat, maybe an overseas gap year ...
OK, so my wife and I aren't naive enough to imagine that these tax-free investments will yield enough to cover all that. But by the time our sons are ready to up sticks, we at least hope there'll be a useful sum in there to help them on their way.
That's why, when the annual CTF statement for our youngest, Jonah, arrived recently, we were surprised to find that as of December, the £310 we began investing last June on his behalf was worth only £238 - a depreciation of around 23%.
Both our sons have "stakeholder" CTFs, where the money is primarily invested in shares, as recommended by the government. The money is managed by The Children's Mutual and invested in the Insight Investment Foundation Growth Fund, the performance of which has closely mirrored that of the FTSE All Share over the last five years.
In many ways, Jonah, whose first birthday is in a few weeks' time, is lucky. Seeing the falling markets, we held back a significant amount of cash we had allocated for his CTF last year - so his exposure was limited to a few hundred pounds, most of which was the government's £250 contribution.
His older brother Ben, who turns four in June, may not be so fortunate. As of last year, his CTF contained just over £3,000, and although the fund had made impressive gains prior to that, we are bracing ourselves for when the next statement arrives. It looks like he might be working his way round that gap year after all ...
Graham Snowdon
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