Locking in the gains

We all want our investments to grow but, for most of us, it is at least as important that they do not shrink. Yet, over the past decade, that has been the dominant trend: the FTSE 100 is below where it started and the stockmarket has halved twice.

Now, two fund managers are offering what should be the investors' holy grail: funds that help your investments grow but make sure they do not fall too much.

Fidelity Equity Growth Defender and Investec Multi-Asset Protector (MAP) funds both aim to limit the falls in their portfolios to 20% of the highest net asset value (NAV) the fund has achieved.

They achieve this by switching in and out of cash depending on how markets are performing but they use completely different methods to decide when, and by how much, to do so.

Contrasting approaches

Fidelity uses a computerised approach, where cash in the fund is determined purely by its performance the previous day: a fall in NAV requiring an increased cash allocation, a rise a lower one.

Investec, by contrast, has taken out an insurance policy in the form of a derivative contract with Deutsche Bank, which will be triggered should the NAV breach the floor.

They also have different investment strategies. Max King, the manager of Investec's MAP fund, can invest across a range of assets, including currencies, commodities and bonds, as well as shares within a fund of funds structure. Fidelity's fund is purely equity and manager James Griffin favours the bigger constituents of the FTSE 100 index.

The products are aimed at similar people: investors approaching retirement who still want some exposure to equities but cannot afford the risk of losing more than 20% of their investment, and those who want to get back into the market but are worried about their timing.

Consistent returns

Both firms say their funds should offer what insurance-based with-profits policies were supposed, but failed, to achieve: relatively consistent returns ahead of cash but without the volatility of pure equity investment. And the protection covers not the initial investment but the fund's peak.

Investec's King says investors should not need to sell the fund: if markets are rising, the fund will be doing well - albeit that the costs of the protection and its multi-asset strategy mean it will lag pure equity funds; if markets are falling, there is the comfort of the downside protection, he says.

There are disadvantages.

First of these is the cost: while Fidelity’s structure means this is not a major issue – it expects a total expense ratio (TER) of 1.46% – MAP fund investors have to foot the bill for the insurance policy, which has averaged 0.25%.

Second, and more important, the very structure of the funds means they will be selling at the bottom and buying at the top, whereas most investment theory recommends doing the opposite. And, if the market falls dramatically, the funds will effectively have to wind up.

Peter Hicks, Fidelity's product director for UK equities, points out that the fund manager will be selling all the way down, rather than dumping everything at the bottom.

But he accepts that the fund will have a high cash balance when markets are at the bottom and it will take time to re-invest, which means it will lag the market as it recovers. 

The fact that the fund moves quickly between equities and cash as markets dictate means it should be able to limit the impact of sharp market falls.

Fidelity's own analysis shows that, if the stockmarket falls by 33%, Equity Growth Defender falls by 10%. To recover to its former value, therefore, the market must rise by 50% of the lower value, while the lower fall in the Equity Growth Defender means it needs only little more than a 10% recovery to get back to previous levels.

For nervous investors, the comfort of protection may be enough by way of compensation.

How do these 
products compare?

Both Fidelity and Investec are careful not to use the word 'guarantee' for their funds. That seems logical: what they are doing is simply capping losses.

Fidelity adds a warning that should the stockmarket fall more than 20% in a single day – something which has not happened for at least 40 years – even that cannot be assured.

But guarantees are slippery things. Structured products, many of which purport to offer guaranteed returns, actually have get-out clauses if individual shares or markets perform in particular ways or the banking partner has its credit rating downgraded. And, unlike those, Investec’s MAP and Fidelity’s Equity Growth Defender can be bought and sold at publicly quoted values at any time.

'Targeted return' funds can be equally slippery. A type of absolute return product, these purport to produce a certain percentage return each year. In fact, many have beaten their targets.

That may sound like a good thing but the point of these funds is to give a particular outcome - and it is surely just as likely they could miss their target at times too.

Financial advisers have also become frustrated with the performance 
of absolute return funds in the current market turbulence. While these are marketed as providing positive returns even when the market is 
falling, far too few have lived up to that promise. Eight of the 36 funds that have been around for a year have made losses over that period, according to Trustnet statistics.

Investec's product has more in common with a cautious managed fund or multi-asset fund, which also switches between asset classes depending on market conditions. As the cost of the guarantee and the depressing effect of the cash impacts on performance, King expects to be in the third quartile compared with these funds, but hopes to make it into the second quartile.

This article was originally published in Money Observer - Moneywise's sister publication - in November 2010

More about