'Cautious' investments can be very risky

Don't assume that a 'cautious' fund is a safe investment. You may be taking a big risk with your money.

The trouble with the stock market is that it’s risky. Some investors have made amazing profits but some spectacular fortunes have also been lost. One classic example is Jesse Livermore. At one point he was worth around $10 billion in today’s money yet he managed to lose all of that fortune and ended his life by committing suicide.   

So it’s not surprising that many people like to invest in funds that are described as ‘cautious.’ No doubt, they hope to get some growth but don’t want to take significant risk. In fact, there’s a whole sector of funds described as ‘cautious managed’ which comprises over 100 unit trusts. Last month sales of cautious managed funds accounted for 37% of unit trust sales, according to Cofunds.   

Some of these funds also include the word ‘cautious’ in their name. Good examples are the Investec Cautious Managed fund and the Henderson Cautious Portfolio fund.   

Trouble is, I think many cautious funds are riskier than you might expect. In fact, a cautious fund can invest up to 60% of its assets in shares with the rest in cash and/or bonds. Given that stock markets can sometimes fall by as much as a third in a year, I don’t think that a 60% investment in shares can in any way be seen as cautious.   

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But that’s just my opinion. Maybe we should look at the performance of this sector before we say definitively that cautious funds are too risky. And, in fairness, the performance of the overall sector is ok. Over the last year, the average fund in the sector has grown by 8.8%. Over the last three years, the average fund has grown by 11.2%. The Investec Cautious Managed fund has done even better and grown by 31.8% over that period.   

However, some individual funds have not performed as a ‘cautious’ investment should. In fact, they’ve performed pretty poorly. The CF Milton Cautious Income Portfolio is a particularly rotten example and has shrunk by 5% over the last three years. You’d have done much better leaving your money in the building society.   

Even worse, Barclays was fined £7.7 million earlier this year for misselling two ‘cautious’ funds from Aviva. Between 2006 and 2008, the bank advised more than 12,000 customers to invest in the funds without properly explaining that these ‘cautious’ funds were actually pretty risky.   

Something should be done   

Saying that a fund that is 60% invested in shares is ‘cautious’ makes no sense to me, and I’m pleased to say that the Association of British Insurers (ABI) agrees. It’s now renaming the sector as ‘Managed Mixed Investment 20-60% shares.’ Funds in the sector must be at least 20% invested in shares with a 60% maximum.   

This name change is an excellent move – potential investors will now know that they’ll be getting significant exposure to the stock market. However, many publications and financial advisers don’t use the ABI sectors. Instead they focus on the sectors as defined by the Investment Management Association (IMA). And the IMA still has a fund sector called ‘Cautious Managed.’ I realise you may be suffering from acronym overload by now, but the important point is that private individuals may still be advised to invest in a ‘cautious’ fund and be told that it’s part of the ‘cautious’ sector, when it’s not cautious at all!   

So what should cautious investors do?   

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Well, if you’re really, really cautious, I suggest you keep all your money in cash in a top-paying savings account. If you do that, you’re almost certain to keep all of your money although the value of your savings may gradually be eroded as inflation takes its toll.   

If you’re willing to take a bit more risk in return for potentially bigger returns, consider buying gilts or a corporate bond fund. Or you could take the plunge and put some of your savings into the stock market, perhaps in an index tracker fund. If you have some money you’re not going to need for at least five years, I’d seriously consider putting some of your savings in the stock market. A combination of cash and shares will make sense for many folk. It’s what I do myself.   

Transparency   

Now you might say that a cautious managed fund offers something very similar – a mix of cash, shares and some bonds too. And that’s true to an extent. Trouble is, some funds weight that mix too much towards shares, and on top of that, many fundholders will probably think that their fund is taking a more cautious approach than is actually the case.  

If you want to make sure that your savings are being managed cautiously, make the decisions yourself. If you want to take a fair bit of risk, you could split your money 50/50 between cash and shares. If you’re more risk averse, you could put 90% into cash with just 10% into shares. By all means take advice from a Independent Financial Adviser, but in the end, the decision should be yours. Don’t rely on someone else to be cautious. 

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