Cautious investors may be at even greater risk

Cautious managed funds topped the best-selling sectors list for the fourth time this year in July, according to the latest Investment Management Association data.

Investors hold some £20 billion in the funds, sales of which typically rise sharply during times of volatility as the promise of risk-managed growth grows in appeal.

The big high street banks all sell cautious managed funds, with the £3.6bn offering from Halifax – part of taxpayer-backed Lloyds Banking Group – the biggest. But there are serious concerns over the way in which the funds are sold to bank customers, fuelled partly by the record £7.7 million fine dished out to Barclays this year for mis-selling cautious and balanced funds run by Aviva.

Tom Munro, owner of Tom Munro Financial Solutions in Larbert, said: “Sales of this type of asset are high as it is the favoured choice of bank advisers, often motivated by the dreaded bonus culture. Too many people are persuaded out of deposit accounts and stuffed into products offered by the insurance company tied to the bank.”

The banks and investment houses selling the funds know only too well that many people will interpret cautious as meaning low risk.

Yet they are anything but. Funds in the cautious managed sector can invest up to 60 per cent of their assets in equities, with at least 30 per cent of the remainder in fixed interest and cash. There are no other criteria for the equity element, which could feasibly be invested entirely in emerging markets stocks.

In the balanced managed sector (similarly popular with risk-averse equity investors), funds can invest up to 85 per cent in equities, with at least 10 per cent of the total fund in non-UK holdings. The fact that funds in both sectors can hold potentially high levels of shares means that when stock markets take a plunge, fund values can also fall sharply.

Patrick Connolly, head of communications at AWD Chase de Vere, said: “Balanced managed and, particularly, cautious managed funds become very popular when stock markets are falling or during times of market volatility. This is because their sector headings give the perception of security, although in this case perception isn’t necessarily reality.”

So while some funds succeed in doing what the sector says on the tin, others fail miserably, either investing too little or too much in risky assets.

“The myth that these funds are an alternative to cash is dispelled over time as scrutiny of the funds frequently reveals very high risk positions taken by a number of managers in the sector,” said Munro.

The average cautious managed fund is down by 0.1 per cent over the past 12 months, but that figure masks a wide gap between the best and worst performers. While the top performer over the past year is up 14 per cent, almost two-thirds of funds in the sector have lost money.

The performance of cautious managed funds over the past three months – a period of market turbulence – undermines any claim to insulate investors from market risks, according to Connolly.

“In that period, 155 out of 164 funds in the cautious managed sector have fallen in value, with the worst fund losing 11.5 per cent,” he pointed out.

“In the balanced managed sector, 129 out of 132 funds have fallen over the period, with the worst fund losing 12 per cent. This compares with the average UK share fund which has lost 9.8 per cent over the period.”

Of the funds in the cautious managed arena that have delivered, Adrian Lowcock, a senior investment adviser at broker Best- invest, likes the Axa Distribution Fund. “It doesn’t set the world alight and performance is consistent with the benchmark, but also able to outperform,” he said.

“It invests in bonds – predominantly index-linked gilts – and shares and the balance has proved successful in recent years. It provides a high level of consistency for investors.”

The balanced managed sector is little better, as far as Lowcock is concerned. “As with cautious managed, the definition of the sector is very wide,” he said. “Up to 85 per cent equity exposure is too high, whether or not it is in UK equity income or emerging markets. Balanced can be interpreted differently; for some it is a straight balance between equity and bonds, whilst for others it is a more diversified approach.”

Comparison of the CF Midas Balanced Growth fund, which has almost 70 per cent in equities, and the Trojan Fund, which has just 42 per cent in shares, gives an idea of how broad the interpretation of the balanced label can be.

All of this means that if you’ve got money in cautious or balanced managed funds, or you’re considering investing in them – perhaps at the behest of a financial adviser – it pays to do your homework first.

“It is really important that investors understand how their funds work and where they are likely to invest,” said Connolly. “Cautious investors must ensure they don’t invest too heavily in shares.”

He recommends looking for truly diversified funds, with holdings spread across a wide range of assets. The Cazenove Multi Manager Diversity is one such fund favoured by Connolly. “This invests one-third in shares, one-third in fixed interest and one-third in a range of other investments and so does a good job of spreading risks.

“Other funds to consider include Fidelity’s Multi Asset Strategic, M&G’s Cautious Multi-asset and the Newton Real Return.”

All of these are in the cautious managed sector, bar the Newton fund, which is under the absolute returns umbrella.

Munro believes that managed funds rarely offer a long-term solution for investors. Ideally, cautious-minded investors should instead have a diversified portfolio that reflects their appetite for risk, he added.

“This is likely to include a large number of underlying funds from across lower-risk sectors such as gilt sand fixed income securities, investment grade corporate bonds and exchange traded funds,” he said.

“This is the correct approach to reducing risk reducing exposure to one investment fund.”