Three years after the crash, the market is still uncertain. Interest rates are rock bottom and investors are more than cautious in the aftershock of the collapse.
So in the low-return environment and with cautious-labelled products under scrutiny it is hard to know where to turn as a less adventurous investor.
Change is under way with product labelling and advisers are now handling cautious investors with even more care – but investor confidence is still low, high returns are needed and there are limited options.
A main problem for the sector is defining what cautious means. With various types of risk to understand and consider, it can be difficult. Most consumers will grasp that losing capital is a risk but most will associate this with the perceived dark side of investment and lack awareness of other risk types, according to an IFA.
Kevin Forbes, partner of Bournemouth-based IFA Strategic Solutions, said: “Advisers have to ask clients what they mean by risk because many are led to believe risk is always capital value. There is the risk of losing your money but there is also counterparty risk, income risk and inflation risk.”
He said the bottom line for cautious investment is accepting that some risk must be taken and establishing what is the most comfortable fit.
The firm, and many others, has been finding it hard to find solutions for cautious investors. Mr Forbes said there is barely anything out there for the low-risk appetite at the moment, so the firm has tried to diversify and spread assets as much as it can to achieve a balanced level.
In the past, UK gilts and US treasury stocks have been examples of what has been considered appropriate options for cautious investors. Now the governments are on their knees, they are not as attractive as they used to be.
It is better not to buy gilts than to buy them, is the opinion of Mr Forbes. However they should not be ruled out entirely.
He said: “In 2007, the government was doing well and investors were offered about 6 per cent at that time if they held gilts. By now in 2011 the government is pretty much bankrupt and interest rates are very low in comparison to inflation.
“The short-term gilts hold less risk. Gilts and corporate bonds with short terms have less price fluctuation so if they are looked at, then the short-term ones are best for lower risk.”
Absolute returns have also come into play with the firm for cautious clients. It confessed that it was more to do with the fact that there is not much else. However, Mr Forbes stressed that with a vast array of different types ranging from low to very high risk, and potentially high costs to invest, advisers needed to be very careful in selection.
He added that investors have been cautious since the recession. Many investors panicked and pulled their money out, when in reality, Mr Forbes said, they had lost it all already and should have invested while everything was so low.
According to RBS research 1.53m people sold investments during the market crash of 2008 because they were concerned about possible further losses and market uncertainty. Some 457,000 retail investors each sold over £10,000 of stock market investments during this period.
RBS analysis of Morningstar data also showed when equity markets fell by about 50 per cent in the US and in Europe between October 2007 and February 2009, more than 80 per cent of the largest funds in the cautious and balanced managed sector adjusted equity exposure by no more than 20 per cent in absolute terms.
Two-fifths of the funds altered their equity exposure by less than 10 per cent. Over this period, the volatility of the funds in these sectors soared from 5.2 per cent to 16.6 per cent
Zak de Mariveles, managing director of global banking and markets for RBS, said: “Cautious and balanced managed are two of the most popular sectors for retail investors, but there needs to be greater transparency around the strategies used by funds here for managing volatility.
“Many investors, especially those choosing cautious managed funds, expect these to be low to medium-risk investments, but some are not. Our research shows that IFAs will not recommend 28 per cent of cautious managed funds because they believe they are too risky. Similarly, they will not recommend 33 per cent of balanced managed funds for this reason.”
He added that reducing the extent of possible losses in an investment is not simply about having a specific limit on equity exposure. Having a dynamic strategy in place for knowing when to increase and decrease exposure to equities and other asset classes is equally important.
RBS has launched two products for the sector. The Volatility Controlled Cautious Managed fund and the Volatility Controlled Balanced Managed fund. The Cautious Managed fund aims not to exceed annualised volatility of 10 per cent, and for the Balanced Managed fund, the corresponding figure is 15 per cent.
Suitability
Labelling of funds as cautious or balanced however has been a cause for scrutiny of late. In its latest assessing suitability paper the FSA stated that firms needs to take care to establish the suitability of any investment selection that requires a customer to take on a higher level of risk than originally identified. It stressed that the level of failure in this area will be met with tough action.
A major impact in this area has been the ABI’s decision to scrap its ‘defensive’, ‘cautious’ and ‘balanced’ sector labels.
It has opted for mixed asset labels and sub-descriptions instead. Its ‘defensive’ fund label will become ‘Managed Mixed Investment 0 to 35 per cent Shares’; the ‘Cautious’ classification will become ‘Managed Mixed Investment 20 to 60 per cent Shares’; and ‘Balanced’ has turned into ‘Managed Mixed Investment 40 to 85 per cent Shares’.
It is also urging insurance companies to think carefully about product naming.
The IMA has not yet followed but has come under increasing pressure to review its managed fund sectors.
Andy Brown, director of investment funds at Prudential, said: “We tend to be very clear when we put a name on that fund. If there is a substantial amount in equities then there needs to be more caution on labelling them cautious investments.
“The ABI has made the right decision. I think this is a move in the right direction. I think the IMA is en route to follow suit. It does not make sense for it not to.”
Mr Brown said Prudential has taken a slightly different route. It has started putting risk parameters in the description of products to indicate the risk corridor.
Mr Brown said having a name is all very well, but you have to go one step further: “You have to explain the amount of risk it will involve and not try to overtake or chase anything more than what has been promised. There is always the choice of a fund manager. Do they sell a risky asset or look at opportunity and sell something else and get a smaller return to accommodate for it in a cautious portfolio?
“The benefit of multi-asset investing for cautious investment is that when an opportunity presents itself you can always take it and hedge with something else.”
An Essex-based IFA firm has turned to multi-manager to ensure risk profiles are adhered to. Plan Money has moved away from constructing portfolios and keeping up with the market. It has opted for multi-manager solutions and a good manager to monitor portfolios instead.
Peter Chadborn, its director, said: “One of the reasons we never moved earlier was because we thought it would undermine what we do with our clients. Sitting down with an annual review with clients, they do not care less what fancy stuff you have been up to at your desk.
“They want to know how much they will have in retirement and how much money they have for their kids’ school fees. That is where they find the value. Once we identified this we switched over.”
He said the attention on cautious investment has been a big wake-up call for a lot of advisers. An adviser cannot just take a simplistic approach and invest into a cautious fund, he added.
The industry is already working to provide greater protection to investors. Under Ucits IV, the key investor information document specifies that Ucits funds should have a risk and reward indicator based on volatility values. The risk of the fund will then be ranked on a scale of one to seven, with seven being the highest.
It might be a little bleak for cautious investors right now, but there are positive signs the industry is moving to resolve the part it plays in investment options. The new Ucits laws come into force on 1 July for new Ucits products and one year later for existing ones.
Nicola Culley is features writer for Financial Adviser
