Too much risk in ‘cautious’ funds
A new report by consumer group Which? has highlighted the amount of risk taken by ‘cautious’ managed funds.
The labels ‘cautious’ or ‘balanced’ managed can often be misleading when attached to a fund.
Because investment risk is subjective, an investor going into a cautious fund might have unreasonable expectations about the degree of caution taken by the fund manager.
Under IMA rules, which dictate the categorisation of such funds, cautious managed funds can hold up to 60% of their assets in equities.
They only need to hold 30% of their assets in lower risk assets, such as cash or fixed interest securities.
With the interest rates available from cash savings remaining at an all-time low, it is important for savers in particular to understand that cautious does not always mean cautious when it comes to investment funds.
A 60% exposure to equities could mean that a cautious fund would fall in value by 12% if the stock markets fell by 20%. Many investors would not define this level of exposure to risk as particularly cautious.
In addition to these levels of equity exposure, the Which? survey found that more than half of the 245 funds in the cautious managed sector invested in ‘alternative assets’, such as derivatives, futures and hedge funds. These can be used to reduce levels of risk but they can also introduce additional risk to a fund.
Our analysis of investment portfolios for new clients often reveals that far too much risk is being taken when compared to the desired level of risk or the required returns from a portfolio.
Here at Informed Choice, we tend to stay away from cautious or balanced managed funds, because they give the investor no control over the underlying asset allocation and therefore the degree of risk being taken.
Our typical approach is to build a portfolio using single asset class funds, thereby placing the investor in direct control over their exposure to different asset classes and the overall level of risk being taken in the portfolio.
This approach also means that we can select the most suitable fund manager in each asset class, rather than relying on a single fund manager to cover all of the investment types. Using this approach, we can blend passive and active funds, leading to a lower total cost than an average managed fund – even when we include the cost of advice and platform charges.
Investors in cautious managed funds should look very carefully at how much risk they are taking with their money. It is essential to look at more than simply the name attached to a fund when investing.
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