Savers hunt for ways to protect cash

The biggest dilemma for deposit account holders is that as soon as funds are invested the capital is at risk, but structured products are available which may have a capital guarantee and offer a variety of potential returns. However, identifying and quantifying the associated risks can be fiendishly difficult and reading the small print is essential.

Over the past year or so, investors have been pouring money into the fixed interest sector, which is regarded as being slightly lower risk than equity investment.

Conventional gilts are debt issued by the government. They pay a fixed rate of interest and will mature at a specified date. However, risk aversion and fears of deflation have caused gilt prices to rise and yields to fall. With a ten-year gilt yielding about 3 per cent there is little attraction for savers requiring income.

A corporate bond is debt issued by a company and as such there should be more default risk involved than a comparable gilt. Corporate bond prices were typically marked down heavily at the peak of the financial crisis. A combination of the high yields available and recovery potential has meant that investments made at the low point have performed extremely well as bond markets rallied, with returns coming in the form of both income and capital.

However, now the investment case is less clear cut, as corporate bond prices have already recovered a lot of the ground lost previously. Despite this, retail sales of bond unit trusts and OEICs in July were 928 million (up from 579m in June), making it the most popular area for investment.

Typically, in an environment of rising interest rates and inflation the fixed interest sector performs relatively poorly due to the "fixed" nature of the income payment. This partly explains why strategic corporate bond funds have been a popular area for investment this year. Basically, a strategic corporate bond fund should have a more flexible investment policy, in terms of the type of asset it can hold, than a traditional corporate bond fund. Therefore, fund managers should have the tools available to them to protect capital if the investing environment deteriorates.

I have supported this view by obtaining exposure to the fixed interest sector via the M&G Optimal Income Fund, and in the investment trust sector we have bought shares of the Henderson Diversified Income Fund. In the UK a number of funds invest globally, and in this sector we have supported the Old Mutual Global Strategic Bond Fund."Contra thinkers", on the other hand, may be heading for the exit as the Retail Bond Platform, launched earlier this year to encourage retail investment in bonds, this week significantly increased the number of bonds available to 89 (previously 24). Perhaps this is the sign that the "top of the market" is near or has been reached?

Next up, the risk curve is investment in commercial property, which again has been a popular area for investors due to a combination of the yields available and depressed prices. Commercial property yields have contracted from 8 per cent last year to a current level of 6.5 per cent (IPD Monthly Index August).

When priced against gilts the yield differential is historically wide, and so investors are being rewarded for taking on additional capital risk. Void rates are falling, new developments are scarce but rental values are still declining and the recovery in commercial property capital values would appear to be ending. Decent returns have been generated over the past year, but we are not currently looking to increase exposure to the commercial property sector.

On the other hand, high-yielding equities are offering far more to savers seeking income. Sentiment remains generally bearish and pessimism about the recovery is widespread. A prospective price to earnings ratio of 10x 2011 earnings for the market is below the long-term average and a current dividend yield of 3.3 per cent on the FTSE All Share Index, forecast for double-digit growth next year, is more than that offered by the previously mentioned ten-year gilt (3 per cent). This traditionally signals a good buying opportunity. Higher-yielding "value shares" have lagged the recovery in the wider market over the past 18 months but the returns have still been attractive.

However, if the market continues to move ahead I consider it likely that the merits of higher-yielding shares will become more fully appreciated and that the performance differential will diminish, perhaps even reverse. Obtaining exposure via managed funds reduces stock-specific risk, and two which we have favoured are the Threadneedle UK Equity Alpha Income Fund (gross yield 5.3 per cent) and the Troy Income Fund (gross yield 4.5 per cent).

Investors seeking income from equities again do not need to confine themselves to the UK market because there are now a number of funds available that either invest globally or concentrate on a specific region. Two funds we have supported which invest globally are the Sarasin International Equity Income Fund (gross yield 5.2 per cent) and the Aberdeen World Growth and Income (estimated gross yield 3.2 per cent).

The growth potential of emerging markets and Asia has been a powerful and popular investment theme over the past couple of years. In Asia, Aberdeen Asset Management is widely recognised as having one of the best investment teams led by Hugh Young. The Aberdeen Asian Income Fund (gross yield 3 per cent), an investment trust launched in 2005, has a good track record both in terms of capital and income growth.

At the other end of the scale in popularity is continental Europe. Oliver Russ, who manages the Ignis Argonaut European Income Fund (gross yield 4.5 per cent) has been highlighting in recent months the investment opportunity that he considers now exists.

Of course there is risk involved and history shows how volatile investment returns can be. However, with the returns from cash eroded by inflation and tax, perhaps the greater risk is to do nothing.

• Charles Robertson is senior investment manager at Murray Asset Management. This does not constitute investment advice and you should take professional advice regarding the suitability of any investments discussed in this article