Investors should be cautious of 'safe' funds

Risk-averse investors place their pots in products tailored to prevent losses. But, says Kate Hughes, many are less safe than you'd think ...

they are popular among little old ladies, those trying to salvage beleaguered pension pots as they approach retirement and first-time investors saving whatever they can scrape together. But thousands of investors who have sought refuge from an economic rollercoaster by turning to the reassuringly named Cautious Managed funds could find they are risking far more than they realise.

The recession, wildly volatile stockmarkets and now the withdrawal of NS&I's index-linked savings certificates and inflation fears have all added to their popularity among the risk averse and today almost £27bn is held in UK-registered Cautious Managed funds according to Morningstar.

"The deep freeze on interest rates is showing no sign of thawing and cash savers are feeling the pain," confirms Darius McDermott of Chelsea Financial Services.

"This has forced income-starved, normally risk-averse savers into the markets. The first port for many of these investors is the IMA Cautious Managed Sector. But buyer beware. Its cautious label should not be taken too literally."

The clue should really be in the name. Cautious Managed funds aim to provide income and capital appreciation without excessive risk. That's why the Investment Management Association (IMA), which dictates how funds are classed, says they should have at least 30 per cent in fixed interest bonds and cash and no more than 60 per cent in higher risk equities.

The idea is that investing in one of these funds protects your money by investing in bonds while using equities to generate returns that are better than the rate of inflation.

"Cautious managed funds usually attract people with limited assets who have fears about market decline but still want to invest," explains David Brennan, a chartered financial planner for Bluefin Wealth Management. "They are often first-time investors, little old ladies, and those trying to make the most of their ISA allowances but who don't trust the stock market.

"With the disastrous withdrawal of NS&I's index-linked savings certificates – which was a great option for risk averse investors – people are looking for alternatives and the cautious managed sector is becoming increasingly popular."

By May this year, a huge £156m of the total £932m invested by private individuals that month was going into the Cautious Managed sector. But these funds don't always do what they say on the tin.

When multi-manager Skandia recently asked investors how risky they would expect cautious managed funds to be on a scale of 1 to 10 – with 10 the most risky, most said 2 or 3.

In fact, more than 60 per cent had a risk rating of 5 or higher, based on fund performance and volatility over the last three years. Less than 20 per cent of cautious managed funds are as cautious as investors expect.

"Fund managers can't have their cake and eat it," Brennan adds. "They say they can protect people's money but are equally after great returns, and that means greater risk. Despite being told to keep at least 30 per cent of their investments in low-risk fixed-interest vehicles, a number of funds have none at all.

"That's just not what you would expect from this kind of fund."

One analysis created for financial advisers shows that the vast majority of cautious managed funds have holdings in emerging markets – one of the riskiest sectors to invest in. In one case, that represents 4.1 per cent of the fund's total – that's over £18m of "cautious" investments.

And this risk is evident in their performances. In the last year, Cautious Managed funds have done well as markets have rallied from the lows of the global recession. Henderson's Managed Distribution fund, for example, is up over 26 per cent year on year.

But on average the funds in this asset class are up by just 0.66 per cent over the last three years of economic turbulence, Morningstar reports. And some, like the Elite LJ Cautious Managed and Miton Cautious Managed funds are down by around 20 per cent over the same period.

Nor do they come cheap.

"Aside from its ambiguous title, my other major gripe with this sector are its fees," McDermott adds.

"In some cases these run to some 3 per cent in management and other fees and there is no evidence that these more expensive funds have produced higher performance over the longer-term."

There are some winners in this sector. The Ruffer Total Return fund, for example, has had a consistently impressive performance – up by more than 46 per cent over the last three years.

Gartmore, Invesco Perpetual and JP Morgan also tend to play by the Cautious Managed rules and could be among the more reliable options.

WHAT YOU CAN DO

* If you have invested in the cautious managed sector and want to find out more about how and where the fund is invested, your annual statement and the fund's factsheet will offer more detail. You can request these from the fund manager for free.

* If you are worried that the fund doesn't reflect your attitude to risk, contact your financial adviser, broker or banking service to discuss your concerns in the first instance.

* The IMA's guidelines for Cautious Managed funds are available at www.investmentfunds.org.uk/statistics/ sector_definitions/definitions.asp.