Investments: Tread cautiously or you could lose your balance

CAUTIOUS investors are inadvertently piling their money into high-volatility funds and risking heavy losses because the products are misleadingly labelled, advisers have warned.

Sales of funds categorised as balanced and cautious managed by the Investment Management Association (IMA) have soared over the past two years as savers starved of returns from cash accounts turn instead to low risk equities. Yet both the cautious managed and balanced managed sectors contain funds that expose investors to a far greater risk than their names suggest.

Private investors have some 21 billion in balanced managed funds, many of which have the maximum 80 per cent of their assets in equities, despite the perception of the funds as relatively low-risk. The funds are designed to provide steady returns over the long-term, but the most successful have been those with the greater exposure to cash and fixed income.

It's a similar story in the cautious managed sector where, despite the name, some funds have the maximum 60 per cent weighting in equities. Private investors have almost 18bn invested in them, including more than 7bn through individual savings accounts (Isas).

But tagging them as cautious is misleading, claimed Graham Bentley, investment specialist at Skandia. "The labels attached to managed funds, such as active, balanced and cautious suggest they are suitable for specific attitudes to risk. The reality, however, suggests managed funds rarely perform in line with expectations due to the wide range of risk and returns that managed funds offer," he said.

That claim is supported by three-year performance. While the top fund in the balanced managed sector over that period has posted growth of almost 50 per cent, 10 of the 150 funds in the sector have made losses.

"I think the descriptors have proved an insufficient way to explain to investors how a fund is run," said Bentley.

Graeme Forbes, chartered financial planner at Intelligent Capital in Glasgow, said cautious managed funds sound, in theory, ideal for older investors who want income to keep up with inflation, without seeing their capital ravaged by equity volatility.

"This sector increased in popularity during the meltdown in 2008, which led to further launches of funds within the sector, with its 'low risk/capital preservation' perception drawing in even more money."

While cautious managed funds can have up to 60 per cent in equities, some also used large percentages in commercial property, "with disastrous results", said Forbes.

Research by Skandia highlighted the gap between the perception of balanced managed funds and the reality. It asked financial advisers to rate funds' risk using its online volatility technology.

Almost nine in ten said they would expect balanced managed funds to measure between 4 and 6 on the risk scale. Yet historic data show that most funds in the sector had a rating of between 8 and 10.

The research found that just 6 per cent of people intending to invest would opt for a fund with a risk score of 8 or 9, yet more than 80 per cent of balanced managed funds have a risk score of at least 8.

Four of the five biggest balanced managed pension funds have a risk rating of 9 and the other is rated an 8, but less than 5 per cent of investors expect the funds to be that far up the scale.

Skandia's Bentley said that didn't reflect on the quality of the funds. "What is vital is that people know what risk scores the funds have that they are invested in so they can tell whether these funds and the risk they carry are in line with their needs and expectations," he said.

Lorna Blyth, investment marketing manager at Scottish Life, agreed with Skandia's findings.

"That funds in the balanced managed sector can invest up to 85 per cent in equities means they're not adequately diversified," she said. "So the word ‘balanced' is very misleading and it's hardly surprising that customers are confused."

Scottish Life's own research found most financial advisers believe 55 per cent is a better equity level for cautious investors, lower than the average balanced managed ratio.

"Another issue is that a managed fund cannot be equally suitable for an investor who is 20 years from retirement and one who is five years from retirement," said Blyth. "Clearly these investors will have to be in different stages of the accumulation phase and are likely to have different risk profiles."

The sheer fund choice on offer to investors makes picking out the most suitable options a daunting task. This is where financial advisers offer value, as they can identify the right assets and funds and re-balance the portfolio when necessary to ensure the investments continue to reflect the investor's risk profile.

Those failing to point out the particular nature of a fund, irrespective of the sector it's in, are effectively guilty of misselling, according to Forbes.

"Similarly, any fund management group that incorrectly labels its fund as a cautious fund and relies on this to draw in money could be reasonably accused of misleading the public.

"It is about time the IMA, the regulator and the fund management industry in general sat down and sorted this."