Parents told to switch to equity child trust funds

The rates offered by cash-based child trust funds (CTFs) are now so poor that even cautious investors are contemplating switching to stocks and shares CTFs, in the hope of better returns in the long run.

The average rate on a cash-based CTF is now just 2.38 per cent, down from 6 per cent last October, according to moneynet.co.uk, the personal finance research provider. Hanley Economic Building Society still offers one of the highest rates at 5 per cent.

This drop in rates is linked to the plunging Bank of England base rate, which has fallen from 5 per cent in September to its current rate of 0.5 per cent. But while CTFs still beat the average returns from mainstream instant access accounts, which now languish at around 0.15 per cent, parents cannot rely on the rates always being good.

“Parents need to look at the funds regularly to ensure they are signed up to the best deals for their children,” said Andrew Hagger of moneynet. “Even if you just want to use the money to give your child a headstart, you need to make sure that money is earning as much interest as possible.”

In recent years, with equity markets in the doldrums, cash CTFs have outperformed stakeholder CTFs – which typically invest in funds that track either the FTSE 100 or the wider FTSE All Share index, and have lost 26 per cent over the past year, on average, according to Moneyfacts.co.uk. But as markets strengthen, investors are being encouraged to take out self-select CTFs managed by stockbrokers which can be invested in a range of funds, stocks and shares, investment trusts or even funds of hedge funds.

Ben Yearsley, an investment adviser at Hargreaves Lansdown, said: “If you’re topping up, people should now look to equity-based CTFs rather than cash.”

The primary motivation for putting money into riskier asset classes is that CTFs are investments for the long term and such assets offer the potential for significantly higher returns over an 18-year period.

For example, if, over 18 years, a parent put £100 a month into a cash-based CTF paying 3 per cent, their child would earn £29,323 at the end of the period, while a rate of 5 per cent would deliver £35,696. But, historically, investments in stocks and shares have outperformed cash – with some stakeholder CTFs having delivered returns of as high as 24 per cent in the bull market.

“A lot of people have unfortunately gone into cash-based CTFs because it’s what they know,” said Ian Benning, head of product development at the Share Centre, the UK broker. “But if anyone is serious about saving money for their children, the equity version is the better deal.”

When it comes to self-select CTFs, the rule is: if an asset is listed on the London Stock Exchange, it’s eligible for inclusion within a CTF.

The government awards every child born since August 2002 a £250 allowance to deposit into a CTF. At the age of seven, children receive another £250 voucher from the government. In addition, up to £1,200 can be invested annually by family or friends before the child reaches 18. As another perk, CTF money can be rolled into an individual savings account (Isa) at the age of 18 – effectively giving children a tax-efficient investment portfolio for life.

During the term of a CTF, accounts can be transferred or moved from cash to stakeholder versions, as long as the entire amount is switched. No penalties will are made for doing so, although providers may charge for dealing costs and stamp duty.

Exchange traded funds (ETFs) – open-ended funds that can be traded – are also attracting CTF money. In recent years, increasing numbers of CTF investors have moved money into ETF funds such as Barclays Xinhua 25 or FTSE Xinhua 25 – two ETFs that each invest in a basket of 25 Chinese companies.

But if you choose not to go down the self-select route, some CTF providers still offer a wide choice of funds. For example, The Children’s Mutual offers Sharia-compliant CTFs tracking the FTSE Global Islamic Index.