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.
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.
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
Net asset value
A company’s net asset value (NAV) is the total value of its assets minus the total value of its liabilities. NAV is most closely associated with investment trusts and is useful for valuing shares in investment trust companies where the value of the company comes from the assets it holds rather than the profit stream generated by the business. Frequently, the NAV is divided by the number of shares in issue to give the net asset value per share.
Structured products offer returns based on the performance of underlying investments. Many products are linked to a stockmarket index such as the FTSE 100 or a “basket” of shares. There are generally two types of product, one offers income, the other growth and investors have to commit their capital for the prescribed term, usually three or five years. The investment is not guaranteed and if the index or basket of shares does not perform as expected over the term the investor might not get back all their capital.
Total expense ratio
Most investment funds levy an initial charge for buying the units/shares and an annual management fee but other expenses also occur in running the fund (trading fees, legal fees, auditor fees, stamp duty and other operational expenses) which are passed on to the investor and so the TER gives a more accurate measure of the total costs of investing. The TER is especially relevant for funds of funds that have several layers of charges. Unfortunately, investment fund companies are not obliged to reveal TERs and many only publish the initial charges and annual management charge (AMC).
An individual employed by an institution to manage an investment fund (unit trust, investment trust, pension fund or hedge fund) to meet pre-determined objectives (usually to generate capital growth or maximise income) in prescribed geographic areas or investment sectors (such as UK smaller companies, technology or commodities). The manager also carries the responsibility for general fund supervision, as well as monitoring the daily trading activity and also developing investment strategies to manage the risk profile of the fund.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
A term applied to raw materials (gold, oil) and foodstuffs (wheat, pork bellies) traded on exchanges throughout the world. Since no one really wants to transport all those heavy materials, what is actually traded are commodities futures contracts or options. These are agreements to buy or sell at an agreed price on a specific date. Because commodity prices are volatile, investing in futures is certainly not for the casual investor.
A financial instrument where the price is “derived” from a security (share or bond), currency, commodity or index. The price of the derivative will move in direct relationship to the price of the underlying security. They often referred to as futures, options, warrants, interest rate swaps and contracts for difference (CFDs). They are mainly used for financial certainty – to protect against spikes in the prices of commodities – as a hedge, whereby investors can buy a derivative that bets the market will move against them so they protect themselves against potential losses. Derivatives are also a tool of speculation as they enable banks, traders or investors to bet on price movements without having buy the actual physical assets. As derivatives cost only a fraction of the underlying asset price, they are “geared” (leveraged in the USA) so if the price of the asset moves £1, the value of derivative could change by £10.
Absolute return funds
Absolute return funds aim to deliver a positive (or ‘absolute’) return every year regardless of what happens in the stockmarket. Unlike traditional funds, they can take bets on shares falling, as well as rising. This is not to say they can’t fall in value; they do. However, over the years, they should have less volatile performance than traditional funds.
A market-weighted index of the 100 biggest companies by market capitalisation listed on the London Stock Exchange. It is often referred to as “The Footsie”. The index began on 3 January 1984 with a base level of 1000; the highest value reached to date is 6950.6, on 30 December 1999. The index is “weighted” by how the movements of each of the 100 constituents affect the index, so larger companies make more of a difference to the index than smaller ones. To ensure it is a true and accurate representation of the most highly capitalised companies in the UK, just like football’s Premier League, every three months the FTSE 100 “relegates” the bottom three companies in the 100 whose market capitalisation has fallen and “promotes” to the index the three companies whose market capitalisation has grown sufficiently to warrant inclusion. Around 80% of the companies listed on the London Stock Exchange are included in the FTSE 100.