Chris Spear of Spear Financial Services says that a lot of his clients with a time horizon of around three years are wrestling with the question of what to do with their cash.
“My main challenge is that a lot of clients are moving out of cash and it’s very difficult to argue against it; however, as an adviser with a regulator looking over my shoulder – quite correctly – I have to recognise not only their attitude to risk, but also their capacity for loss, which I think is causing a lot of advisers concern,” he said.
FE Trustnet asked industry experts what their preferred options were for investors with a three-year time horizon.
Cash
This week saw inflation figures fall to 2 per cent, the lowest since November 2009, meaning that the value of cash is eroding more slowly.
Bond markets are also pricing in a rate-rise in November of this year, albeit a small one, which would also feed through into higher rates for holding onto the security of cash.
However, Gordon Smith, fund analyst at Killik & Co, warns that this optimistic view for cash could end up being over-stated.
“On a three-year horizon there’s still a lot of uncertainty around inflation, so I would look at investing it, unless you anticipate a short-notice call on your capital.”
However, it is worth bearing in mind that a number of commentators have been warning that markets could be due a dip and it could be prudent to hold on to your cash for a little while longer.
Kevin Gardiner of Barclays Wealth outlined this view to FE Trustnet yesterday.
Investors who are thinking about coming out of cash at this point in time could decide it is prudent to hold on for a few months and see what happens to markets.
On the other hand, this means accepting negligible real or even negative rates.
Unorthodox bonds
“Pension funds do lifestyling for investors nearing retirement, but this often means moving you into bonds and is that really sensible at the moment?” Spear said.
This is at the core of the quandary for most people. Bonds have traditionally been used to lower the volatility on portfolios as the investor approaches retirement through their uncorrelated relationship to equities.
Historically, bonds would be expected to fall in price as riskier assets such as equities surged and vice versa.
However, last year saw the spectre of a double correction in both asset classes, and with yields ground into the dirt on investment grade bonds, many commentators warn there is little scope for price rises on fixed interest, whatever happens to equity.
Performance of bonds and shares over 1yr
Source: FE Analytics
Killik’s Smith says that investors should consider moving into bond funds that have more flexibility in what they can invest in.
“It’s difficult at the moment. There are areas of the fixed income space that do protect you from duration risk,” he said.
He rates the PFS TwentyFour Monument Bond fund, run by TwentyFour Asset Management, which invests in asset-backed securities.
“The Monument Bond fund only invests in high-quality UK, European and Australian residential mortgage-backed securities (RMBS) with at least a BBB- (or equivalent) investment grade rating at the time of purchase,” he said.
“Asset-backed securities (ABS), such as RMBS, are bonds backed by discrete pools of receivables (in this case residential mortgages) or other such financial assets (such as automobile loans, credit cards or corporate loans).”
“There are a number of attractions of the structures of such securities. The coupon and principal payments of ABS bonds have direct recourse to the underlying assets.”
“The securities are structured within a segregated legal framework and often split into tranches, with junior segments absorbing losses ahead of those more senior.”
“Unlike corporate bonds, ABS are typically amortising loans, leading to improving credit quality over time.”
The fund has returned 20.21 per cent since launch in August 2009, according to data from FE Analytics.
Performance of fund vs index since launch
Source: FE Analytics
The yield is currently 2.49 per cent, according to data from FE Analytics. It has produced an annualised return of just 3.88 per cent over the last three years, however.
Absolute return funds
Some investors use absolute return funds instead of bond ones, although these won’t work for anyone looking for a yield.
“What you are trying to do is just beat cash, so you are giving up a lot of return,” Spear said.
“Absolute return funds I like, but they do have the potential to go wrong as well.”
There are many different types of funds, and FE Trustnet examined the sector in some detail in a recent review.
Some of the funds use a multi-asset approach to minimise volatility, others are long/short equity funds that try to protect themselves with short positions from market falls.
Some of the most successful ones have done very well in the recent market rally, but Spear points out that this doesn’t bode well if there is a correction, when investors will be left exposed to the skill of the manager.
“If they can go up 30 per cent in a year, they can go down 30 per cent too,” he said.
Spear says he likes Standard Life GARS, the UK’s biggest retail fund, and is also looking at Invesco’s recent start-up rival: Invesco Perpetual Global Targeted Returns.
Protected funds
Spear says that one less well-known option investors have is to look at so-called protected funds – the IMA Protected sector is devoted to these.
These funds work in a similar way to structured products and have similar drawbacks. There are many ways they can work, but in general an investor is given assurances that they will receive a minimum sum, perhaps expressed as a proportion of the gains of a benchmark, with the potential for more if markets do particularly well.
The idea is to give a floor to your returns, but one of the problems is they can be hard to understand. An investor is unlikely to be given absolute assurances, but only conditional ones, which can lead to them being unhappy when the returns they expect do not materialise.
Often the funds use derivatives to provide their assurances, and the manager may not be able to use them as they wish.
FE Analytics data shows that there were no protected funds launched in 2013 and only one in 2012, and they now seem to have fallen out of fashion.
“The other area would be in maybe a diversified defensive equity fund, something that’s getting you an exposure to lots of defensive equity names and paying a yield at the same time, which gets important if you have a short-term horizon,” said Spear.
Defensive equities
Both Spear and Smith argue that if you have a three-year time horizon, you are probably better off in defensive equities along with some strategic bond funds, although this means taking on more risk.
“You probably are better off in the stock market, but so much can go wrong,” Spear said.
Smith likes Terry Smith’s £1.6bn Fundsmith Equity fund, which was recently awarded five FE Crowns.
“It gives you a list of fairly strong brands with low leverage,” he said.
Our data shows that it has made 51.35 per cent over the past three years while the MSCI World index has made 30.02 per cent.
Performance of fund vs sector and index over 3yrs
Source: FE Analytics
Over that time period it had an 11.08 per cent volatility score compared with 14.31 per cent for the benchmark.
Smith also likes the £62m Fidelity Global Dividend fund, managed by Dan Roberts. Our data shows it has made 34.71 per cent since launch in January 2012 while the IMA Global Equity Income sector has made 28.98 per cent.
Performance of fund vs sector and index since launch
Source: FE Analytics
The Fidelity fund has ongoing charges of 1.81 per cent while Fundsmith Equity charges 1.69 per cent.
