It is no secret that bank accounts are delivering ridiculously low yields. With inflation running at 2.8 per cent, it is nigh on irresponsible to leave a significant proportion of your capital in cash.
As Chelsea Financial’s managing director Darius McDermott (pictured) points out, investors who are more cautious about putting their money in the market do not have the clear-cut choice they did before markets transformed in 2008.
However, he says it is vital that savers become investors and aim to grow their capital at a higher rate than inflation so they can live the lifestyle they aspire to in retirement.
"Inflation is an unspoken about danger," he warned. "Historically, if you wanted a return above cash, the natural extension was bond funds. But as bond funds have had a spectacular 30-year bull run and interest rates have come down, we know interest rates will go back up at some point, and when that happens the capital value of bonds will be really under threat."
As McDermott highlights, bonds are not the obvious next step up the risk ladder they once were, which is why he thinks absolute return funds are poised to rise in popularity.
Absolute return funds have a cash-plus target at around one-third of the volatility of equities. While the sector has been the focus of a lot of criticism for failing to meet this target over the short-term, McDermott says there are a number of decent funds in the sector that can deliver exactly what cautious investors need in the current economic climate.
"There are decent funds with a cash-plus target and lower volatility [than equities] and that is acceptable to cautious investors," he said.
"If they can continue to give cash-plus returns with low volatility, then they will be satisfying a bucket of primarily cash investors. I’m not saying absolute return is for everyone, but for the lower-risk investor looking to move up the scale, absolute return funds should be fighting their corner to be that next choice."
One of McDermott’s favourite funds in the sector is the four crown-rated Absolute Insight Equity Market Neutral fund, managed by Andrew Cawker.
"The Market Neutral fund is truly a lower-risk fund. It is targeting something like cash plus 2 per cent. It never makes a lot of money, but it never loses a lot of money either," he said.
The £800.9m fund has successfully outperformed the LIBOR Libid GBP 3m index over one, three and five years. As McDermott mentioned, it is not a "shoot the lights out" fund and has performed roughly in line with the average fund in the IMA Targeted Absolute Return sector over each period.
Over the last five years, it has made 15.65 per cent while the cash index gained a mere 4.96 per cent, according to FE Analytics.
Performance of fund vs sector and index over 5yrs
Source: FE Analytics
More importantly, the fund has delivered a positive return and beaten the LIBOR index in every calendar year since launch and year to date.
The fund requires a minimum investment of £3,000 and has ongoing charges of 1.17 per cent.
McDermott also likes Cawker’s more recently launched BNY Mellon Absolute Return Equity fund, which aims to beat the Euribor 1 month index, which it has done since launch – its returns of 11.69 per cent almost doubling the sector's.
Performance of fund vs sector and index since launch
Source: FE Analytics
While the fund only has one full calendar year under its belt, it did beat Euribor in 2012 when the index lost 2.58 per cent, picking up 5.9 per cent. It is also ahead of cash so far in 2013.
It requires a minimum investment of £5,000 and has ongoing charges of 1.65 per cent.
McDermott also highlights the larger Newton Real Return fund, managed by FE Alpha Manager Iain Stewart.
The £8.3bn fund has outperformed LIBOR GBP 1m over the last one, three and five years and has a yield of 3.01 per cent to boot.
Over the last five years it has picked up 36.97 per cent while the sector and index made 16.24 per cent and 4.48 per cent respectively.
Like the Insight and BNY Mellon portfolios, Newton Real Return has a strong track record of beating the Libor index over every calendar year, apart from the down markets of 2011 when it slipped and lost 0.75 per cent. The index made 0.65 per cent that year.
It requires a minimum investment of £1,000 and has ongoing charges of 1.12 per cent.
Volatility is a key concern for cautious investors, and each of these funds lives up to their aim of delivering cash plus returns with lower volatility than equities.
The Absolute Insight Equity Market Neutral fund has the lowest volatility of the portfolios, at just 1.58 per cent annualised over the last 12 months. As a point of comparison, the FTSE All Share has a score of 11.04 per cent over the last year.
