Constructing investment portfolios can be a minefield at the best of times.
However, the Japanese earthquake and tsunami, the Arab Spring and the bear market in August made 2011 an even more difficult year for investors to allocate their assets appropriately.
This led to aversion to risk, as most investors fled to safe haven asset classes or retained their money in cash in order to preserve their savings.
According to the IMA, the top-selling sectors for retail investors in 2011 were the IMA Cautious Managed, IMA Balanced Managed and IMA Sterling Strategic Bond sectors, which saw combined inflows of more than £2.4bn.
With £1.4bn of that going straight into the IMA Cautious Managed sector, could investors have been attracted to these funds simply because of their name, or were they really the best choice?
Labelling
Research by Skandia last year found that roughly 90 per cent of financial advisers believe that funds labelled ‘cautious’ lull investors into thinking their investment is safe, yet the reality is often very different.
This common misconception led to the IMA renaming the Cautious Managed sector Mixed Investment 20-60 per cent Shares, on January 1 2012, in the hope that it will create more clarity for investors.
This means funds that now label themselves ‘cautious’ will mainly only be able to invest between 20-60 per cent in equities and half of the money that they hold has to be in the UK or Europe.
Patrick Connolly, head of communications at AWD Chase de Vere, argues: “The IMA was rightly forced to change the sector headings because the previous descriptions, while being great for investment companies trying to promote their funds, were potentially misleading.
“What they have achieved are headings which aren’t misleading, which are aligned to those used by life insurance companies and where investors should be more focused on understanding individual funds rather than assuming that all funds in a sector are similar. If an investor selects a cautious managed fund they quite rightly expect that fund to be cautiously managed,” he adds.
Martin Bamford, managing director of Informed Choice, agrees that the rename made sense, but argues that with many funds continuing to refer to their strategy as cautious, there is still room for confusion.
“Cautious can be a rather misleading title for a fund. The names of risk levels are very subjective and should be considered on conjunction with the financial goals of the investor. Too often, fund names are considered in isolation from investment goals,” he says.
“Holding up to 60 per cent in shares is certainly more cautious than an equity only strategy, but relative to most expectations of ‘cautious’ it is too high risk.”
Mr Connolly agrees. “Many people would consider 60 per cent in shares to be quite risky,” he says. “In 2008 the average cautious managed fund fell by 16 per cent, with some funds falling by more than 30 per cent. This cannot be described as a cautious investment.”
Risk scale
According to Skandia, most investors would score cautious funds as between two or three out of 10 on a risk scale – with 10 being the most risky. But in reality, the majority of cautious funds carry a risk rating of five or six – and some scored even higher.
Mr Bamford says: “When held for the long-term, some investors are prepared to accept the higher levels of risk associated with most cautious funds.”
However, cautious investors tend to be more concerned with volatility in the short term and this makes them less likely to hold investments for long enough periods of time to see the desired results.
He adds: “Our own equivalent of a cautious strategy has a strategic allocation of 33 per cent in shares, 13 per cent in cash, 44 per cent in fixed interest securities and 10 per cent in property. We place this portfolio at number three on a scale of one to 10.”
Moreover, in support of Mr Connolly and Mr Bamford, data from Morningstar shows that picking more volatile – by some measures, riskier – investments is not necessarily guaranteed to increase performance over all time periods.
According to Morningstar’s monthly assessments of volatility over the three years to March 9, the Invesco Perpetual European High Income fund was the most volatile fund in the peer group, with fluctuations on this measure of 4.5 per cent.
In terms of total returns, the fund was 10th out of 121 funds in the peer group. The steadiest fund over the period, Neptune Cautious Managed fund, whose volatility was measured at 1 per cent, also ranked 120th out of 121 funds in the peer group in terms of its total returns.
However, over one year the Invesco Perpetual fund ranked 132 out of 156 funds in the peer group in terms of performance. The Neptune fund ranked 111th.
Carl Hess, global head of investment at Towers Watson, says: “We would still caution investors against taking on more risk, even in light of ongoing market rallies.
“The move into positive territory for many markets this year is helpful but largely reflects central bank liquidity and may not prove sufficiently sustainable to justify a strategic move back into risk assets or indicate a cyclical recovery.”
Mr Connolly concludes: “The truth is there are pretty big differences between the funds in these sectors and so an accurate ‘one size fits all’ title would be almost impossible to achieve.”
Simona Stankovska is features writer at Investment Adviser
