It really is possible to increase the return from your capital while reducing the level of risk.
How can this be? It’s because in the short term (under about five years) the risk of loss is largely caused by volatility, the tendency of asset values (shares and property in particular) to go up and down more or less randomly.
The ’more or less’ covers the difference between periods when it’s obvious that there is a trend, for example house prices rising steadily between 2000 and 2004), and those when nobody knows what’s about to happen, like share and house prices now. At these uncertain periods you can see sudden shifts that cause prices to fall sharply. In May the prices of shares worldwide dropped 10-15%, but the prices of oil and mining stocks are still lower than their May levels while most others have since recovered.
See our Best Buy Cautious Managed funds
Hindsight is always 20/20
Actually, there are more of these uncertain periods than you might think, because a trend is usually obvious only with hindsight. Between 2002 and 2004 a lot of investors just didn’t believe the stock market was in recovery mode - most of the headlines were still about companies going bust - so they stayed in cash and missed out on gains of 50% or more.
So there are two types of short-term risk: losing money when prices fall unexpectedly, and missing out on gains by having your capital in cash when prices rise strongly. This comes to the same thing as saying that while holding shares is risky, so is holding cash.
Yes, most of us feel differently about missing out on gains than we do about losing money (there’s more pain in losing than there is pleasure in gaining), but one of the things you need to do to be a successful investor is to ’correct’ for your emotional biases.
See our Best Buy Cautious Managed funds
Mix your investments to cut risk
The obvious conclusion is that you incur less risk if you always hold a mixture or shares and cash. This issue is explored in more detail in our
Guide to Asset Allocation which can be downloaded from the home page.
And that really is the key to the success of a group of collective funds that divide their money between shares and fixed interest investments: Cautious Managed Funds. The Cautious means they will never hold more than about 60% of the capital in shares. And they use fixed interest because it is possible to get higher returns here than from cash, while at the same time having a high degree of capital security.
| Performance of our selected Cautious Managed funds | |
|
Investment return over |
| Funds |
6 months |
1 year |
3 years |
5 years |
| CS Multimanager Cautious Managed |
-1.8% |
+7.9% |
+37.7% |
+54.6% |
| Garmore MultiManager Cautious Strategy |
-0.9% |
+8.0% |
N/A |
N/A |
| Investec Cautious Managed |
-0.3% |
+7.1% |
+33.8% |
+53.5% |
| Ruffer Total Return |
-4.7% |
+1.6% |
+28.3% |
+62.7% |
| Threadneedle Defensive Equity & Bond |
+0.1% |
+5.5% |
+22.8% |
N/A |
| Cautious Managed sector average |
-0.9% |
+6.7% |
+31.8% |
+41.3% |
|
|
| Invesco Perpetual Distribution |
+3.5% |
+10.1% |
N/A |
N/A |
Data to 27/9/2006. Source: Trustnet
See our Best Buy Cautious Managed funds
Doing what it says on the tin
As the chart shows, the managers of Cautious Managed funds have done what they set out to do. By early 2003 an investor who bought UK shares in late 2001 would have been showing a loss of 20% on their original investment, while the average Cautious Managed fund showed a drop of just a couple of percent.
Since then, UK share prices have risen pretty consistently, but Cautious Managed funds have fluctuated less in price and note how they showed a much smaller drop in May 2006 when share prices worldwide took a sudden 10% tumble.
Cautious Managed Sector Average
UK All Companies Sector Average
See our Best Buy Cautious Managed funds
Timing the switches
The other key to the success of Cautious Managed funds is that the managers have the freedom to adjust the proportions in shares and fixed interest. The norm is that they may hold a maximum of 60% in shares or fixed interest. In practice, they have switched from a roughly 60-40 split in fixed interest and shares to a roughly 40-60 position, taking advantage of the share price uptrend of the past three years.
In recent months most managers have been getting more cautious. Henry Maxey at Ruffer is scared of ’bubble’ conditions in the credit markets, where hedge funds are using vast quantities of borrowed money to speculate in junk bonds that are of far lower quality than ever before. He has 20% of his fund in cash deposits and almost 60% in bonds with just 24% in shares.
Threadneedle has 33% in shares and 66% in bonds and at Invesco it is bonds 61% and shares 36%. Gartmore has 55% in shares but holds 14% in cash and has 11% in property (it is the only fund to include commercial property) as well as 20% in bonds. The odd man out is Credit Suisse with 66% in shares and just 25% in bonds.
See our Best Buy Cautious Managed funds
Dream team joins the list
We are adding one new fund to the list: Invesco Perpetual Distribution. This is run by what can only be described as the fvie-star dream team: Neil Woodford, the most successful equity income fund manager, is in charge of picking shares, while Paul Causer and Paul Read, the highly successful managers of Invesco’s fixed interest funds, look after the rest. Now that the fund has a two-year track record, it’s clear it is up with the best and over the long term I expect it to be one of the top performers in the sector. This and Alistair Mundy’s Investec Cautious Managed Fund are my two top selections in the sector.
Important risk warning - please read
The value of your investment and the income from it can go down as well as up and you may not get back a significant proportion of your investment. Past performance is not an indication of future performance. If you are in any doubt as to the suitability of an investment, you should seek independent financial advice.
