Safety first for the cautious investor

Posted by Liz Rees in Weekly musings category on 05 Apr 19


The current era of low interest rates means it is nearly impossible to find a single asset class that can preserve the value of your capital at all times. Moreover, those who stay in cash bear the risk of their wealth being eroded in real terms by inflation.

Bond funds: low risk but not no risk

Bond funds have traditionally appealed to investors with a low appetite for risk. These pay a fixed income with the face value of the bond being returned to the investor when it matures, though only index linked bonds can help to protect from the ravages of inflation. Furthermore, if interest rates rise so do bond yields which pushes down their prices.

Compared to other categories of bonds, government bonds have tended to show the lowest correlation with shares, usually demonstrating their safe haven status when shares prices fall. This is most evident during periods of economic slowdown. Corporate and high yield bonds, which carry higher risk of a default, tend to move in the same direction as equities just to a lesser extent.

UK gilts funds do not currently offer compelling yields while corporate bond specialists have had to take on more risk to produce good levels of income. Strategic bond funds have the advantage of being able to cast their net wider and can invest anywhere in the bond universe. Ariel Bezalel, the manager of Jupiter Strategic Bond Fund, adopts a cautious approach with over 40% of his portfolio in government bonds.

Diversify to reduce risk

Following the financial crisis we have seen an increase in demand for funds that aim to reduce volatility, and deliver steady returns. Such strategies try to avoid large losses during market downturns, although a focus on lower risk assets and diversification means they are likely to lag strongly rising equity markets.

The concept of capital preservation and/or target returns will appeal to many investors, but it is important to investigate the techniques involved, such as the use of derivatives. The costs of implementing more complex strategies can be expensive.

Multi-Asset Funds: Low correlation not no correlation

Multi-Asset funds invest in a wide range of assets and are often designed to meet a specified risk appetite. The more cautious portfolios have the highest weighting to bonds, in particular government bonds, with some exposure to corporate and high yield. They also have a limited exposure to shares, and some may diversify further using alternatives such as property, gold and other commodities.

Alternative asset classes are used to try and improve returns but with less risk. They are by no means risk free, but their differing characteristics mean they may offer uncorrelated returns.

Willis Owen has produced a list of Morningstar-rated cautious multi-asset funds for investors who prefer to outsource asset allocation decisions.

Targeted return funds: understand what you buy

Funds in the Investment Association’s Targeted Absolute Return sector must aim to produce a positive return after fees in any market condition, though this is not guaranteed.

Some managers focus on risk control to produce modest but steady returns, while others are positioned more aggressively. Derivatives may be used to reduce volatility and preserve capital, but also to generate yield or to make big calls on the overall market or individual companies.

A multi-strategy approach, investing globally and in different asset classes, may suit those seeking capital preservation more than single strategy funds which focus on one region and asset class. However, be aware that popular multi-strategy funds, including Standard Life GARS and Invesco Global Targeted Returns, employ complex strategies which have not performed well in recent years.

Popular for pensions?

For investors in drawdown, capital preservation is important because any falls in the value of your portfolio early in retirement are hard to recover from because of the need to draw a regular income. Increasing longevity also means that the pension pot needs to last longer, so a broad spread of assets is needed to meet these requirements.

Diversified income funds, for example Kames Diversified Monthly Income, are designed to produce both decent income and sustainable growth. They may have more exposure to shares but it’s worth remembering that these have been the best performing asset class over the long-term. Quality companies should provide a healthy dividend stream even if stock markets dip for a while.

More options for the cautious investor

Anyone who is worried about economic downturns, political instability or valuation levels, yet wants to invest, could consider funds with a good track record for preserving capital.

In the Target Absolute Return Sector, Newton Real Return aims to deliver cash plus 4% over 5 years and a positive return on a rolling 3 year basis (not guaranteed). The fund invests in securities globally, using financial derivative instruments where appropriate.

BlackRock UK Absolute Alpha and Janus Henderson UK Absolute Return are single strategy funds which look to profit from UK share prices falling as well as rising, while Jupiter Absolute Return has a wider geographical remit and its positioning currently reflects a negative stance on US growth companies.

Several Investment trusts have a capital preservation mandate. RIT Capital Partners, established in 1961 to manage the money of the Rothschild family, has a strategy to preserve shareholders’ wealth and deliver long-term growth through a multi-asset approach. However, it presently commands a significant premium to Net Asset Value (NAV).

Ruffer Investment Company aims to achieve a positive total annual return, after expenses, of at least twice the Bank of England base rate by blending bonds, cash, gold and equities. After a somewhat disappointing 2018, the shares trade at a discount to NAV. The open-ended equivalent from the same team is Ruffer Total Return.

Personal Assets Trust combines defensive and high-quality equities with government bonds, gold and cash. It trades on a small premium to NAV. Manager Sebastian Lyon manages an open-ended fund, Troy Trojan, along the same lines.

In truth, there are no completely risk-free investments, so the best approach is to be well-diversified and always be prepared to ride out short-term fluctuations.

Important Information: We do not give investment advice so you will need to decide if an investment is suitable for you. If you are unsure whether to invest, you should contact a financial adviser. 

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