Cautious approach suits volatile times

Investors looking for a safe haven for their money after the recent falls in global stockmarkets have several options, not least of which is switching their assets to a cautious managed fund.

Given the gyrations of the stockmarket over recent weeks, many investors must be wondering if there is such a thing as a safe haven for their money. Defaulting to cash is always an option, of course, but more creative ways of reducing the risk in portfolios have been developed in recent years. Including those funds with little correlation to the likely behaviour of equity markets, or where volatility is likely to be significantly less, is now an accepted part of portfolio planning. But where should investors run to when the going gets tough?

One option is the wide range of money funds now available. But looking at the returns they have recently generated suggests they need as much careful vetting as any other option. While you would not expect the performance delivered to shoot the lights out, it is surprising how much variation exists between individual funds. Remarkably, some have even delivered negative returns – difficult to believe possible in a money market fund. It does, however, depend upon the nature of the instruments and, indeed, the currencies in which they invest.

Take the one-year tables, for example. Well in the lead is the Old Mutual US Dollar Money Market fund, but over six months and three years you would have lost money – 8% over the longer period. This reflects the way in which the dollar has fallen in and out of favour in recent years.

Not that this fund is the only one to have delivered negative returns. The Insight Investment Cash fund is also down over six months and three years, suggesting a similar exposure to the dollar. The falls over six months were negligible for both funds, while the Insight fund lost 6.6% in value over three years. Unfortunately, it could only manage a 1% rise over one year.

If money market funds are not the answer for those seeking a smoother ride, what options are open to the risk-averse investor? Clearly, asset diversification is one way of achieving a degree of protection. Not guaranteed, that is true, but including property and so-called alternative investments is one way of achieving a better chance of riding out the type of storm that will assail markets from time to time. Bond funds, too, will give access to an asset class that has much less correlation to long-only equity funds. Or you could pay someone else to take out the risk for you.

Cautious managed funds, as a group, have expanded massively recently. With 73 funds as at the end of April, the number available has gone up nearly 90% over the past three years. Perhaps it is a function of the persistent bear market that ushered in the millennium, but investor appetite for this style of (relatively) risk-averse fund has grown significantly in recent years. Not that risk averse necessarily means low returns. The best-performing fund – CF Midas Balanced Income – has delivered a total return of more than 70% over three years.

Just as important is the absence of negative returns for these funds. While it is true to say that markets have been benign since early 2003, these funds tend to cluster around the average in a more consistent way than in other groups of unit trusts or Oeics. Take the six-month tables, for example. The average is a rise of 9%. The range varies between 17.5% and 1%, but the figures change quite dramatically as you move away from the best and worst performers. Move just six funds in from either extreme and the band of performance achieved narrows to between 5% and 13%.

The growth of multi-manager funds has had an impact on this sub-set of the fund groupings. Credit Suisse, where Robert Burdett and Gary Potter have built a powerful franchise, feature strongly in the tables, while the Jupiter Merlin offering also shows an above-average performance. While these fund of funds offerings arguably suffer from higher costs than directly invested funds, the disciplined approach to tactical switching now adopted by the best of these managers clearly delivers results.

Cautious managed funds are clearly appropriate for a wide range of clients, but will not necessarily be the answer for those concerned at the way in which volatility has returned to markets. Much of the reason for the recent turmoil can be laid at the door of what might be described as “irrational exuberance”. In the rush to jump on the bandwagon of rising markets, money has flowed in to sectors such as commodities and emerging markets – debt and equity – driving values to unsustainable levels.

At the same time, fears of rising inflation, and thus higher interest rates, have rekindled fears that prolonged economic growth might not be sustainable at current levels. Place this against a background of rising personal debt in the developed world and a twin deficit problem in America of almost unimaginable proportions and it is little wonder that risk is once again a prime concern to investors.

In time, this situation should resolve itself. And my money is on the British market at least ending the year higher than when it started. For larger or more sophisticated investors, asset diversification in a considered way should be enough to take out the worst of any potential volatility overall. For smaller investors, or those who feel particularly nervous when the headlines scream “Billions wiped off share values”, cautious managed funds could indeed provide enough involvement in the market without the sensation of riding a particularly violent rollercoaster.