I have been advised to invest in a cautious fund in the stock market but have read about how some cautious funds are really quite risky. Are they suitable?

It really depends on what the word 'cautious' means. It's purely marketing twaddle for me, and I don’t believe investors are well enough informed on what it actually means when choosing a fund. I'll start with the punch line which will keep your attention through the rest of the column.

In order to make fund choice easier, sectors are created such as 'active managed', 'balanced', 'cautious' and 'Japan'. Each sector is given guidelines for investment and the funds which apply to go into this sector have to stick to these principles. For example, the cautious managed sector's guidelines insist that a fund has to invest in a range of assets where the maximum equity (stocks and shares) exposure is restricted to 60% of the fund. At least 30% of the portfolio must be invested in fixed interest and cash. There is no specific requirement to hold a minimum proportion of overseas equity but overall, the portfolio must have minimum 50% Sterling/Euro exposure.

This supposedly enables you or your financial adviser to be able to build a portfolio of investments from each of the sectors which effectively reduces your risk.

Advisers and investors alike would be forgiven for believing that any fund inside the cautious sector was safe to use as 'cautious', but the reality is quite different. The fund with the highest risk in the sector is 349% riskier than the lowest risk fund.(1) The highest risk fund in the cautious sector is actually riskier than the majority of funds in the active managed sector (which is classed as above medium risk). In fact there were only twelve funds in the entire active managed sector that had a higher risk than it.

The performance is also quite interesting. The average performance over the last five years for the cautious managed sector is 13.1% (2) The best performer returned 54.7% yet the worst offered a measly -7.1% over the five year period. It was notable that the AXA defensive distribution fund was in the bottom three with a return over the five years of -5.5%, 60% worse than the best performer. Santander, CF Miton and CF Midas, along with Insight, were also all guilty of posting negative returns over the period.

This is truly an amazing difference, and one can only assume they have very different investment philosophies in what is supposed to be a cautious sector. That is of course until you apply the research a good investment adviser would apply.

On closer inspection, what is supposed to be a benign sector is actually a bucket of 'stuff'.

The sector can have up to 60% in equities. Some won't go as much as 40% in equities but are still in the same sector. Others have a high equity content but then select a large content of high yield bonds (junk loans to companies) which provides a poor variance (balance) from equities as they have a much greater co variance with equities than that of investment grade paper. So you could be invested in double the risk as opposed to a spread.

And so, the cautious fund exposed to 60% in equities and maximum high yield bonds will have enjoyed a fantastic last eighteen months, just in time to suck in the cautious investor with their cumulative performance advertisements. The lower risk alternative within the cautious sector with exposure to high grade bonds, gilts and 40% equities will have underperformed but they will have delivered to the need of the cautious investor.

Their poor performance over the last 18 months in comparison to the aforementioned fund will not attract the investor when they assess this sector. They will be attractive after the next downturn, however, but that's just when investors should be looking for the upside return in the market. And so investors are constantly moved in and out of cautious funds at completely the wrong time, losing pounds after pounds of their hard earned cash.

For a fact sheet on cautious funds call Peter on 0845 230 9876, e-mail info@wwfp.net or take a look at our website.


The value of shares and investments can go down as well as up


1. Lipper

2. Trustnet

Peter McGahan is an Independent Financial Adviser and the Managing Director of Worldwide Financial Planning Ltd who are authorised and regulated by the Financial Services Authority. 'The FSA does not regulate Credit Cards, Will Writing and some forms of mortgage and Inheritance Tax Planning.'

Information given is for general guidance only, and specific advice should be taken before acting on any suggestions made.
The above represents the personal opinions of Peter McGahan.
All information is based on our understanding of current tax practices, which are subject to change.

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