UK cautious managed funds aim to find the middle ground for investors, providing a combination of in...
UK cautious managed funds aim to find the middle ground for investors, providing a combination of income and long-term capital growth through an actively managed diversified portfolio of equities and bonds.
Many investors have reassessed their investment goals following the disappointing returns equities have produced over the past few years, particularly in comparison with bonds. Given the still-uncertain global economic outlook and prospect of further equity market volatility, we believe the case for the more balanced proposition offered by these funds remains compelling.
The way cautious managed funds operate is relatively straightforward. Effectively, they look to take advantage of the valuation and market opportunities offered by bonds and equities at different times by adjusting the balance of the portfolio between these two asset classes within certain pre-defined limits. For example, equities currently appear cheap relative to bonds and a cautious managed fund has the opportunity to take advantage of this to weight the portfolio in favour of equities.
Over the longer term, however, this situation may change, with periods of equity market strength likely to be spasmodic rather than a steady trend.
This is important because if we are correct and equities deliver short, sharp bursts of strength, the ability to switch into bonds will enable these funds to exploit the situation fully, as bonds are very likely to have weakened at the same time.
This is clearly illustrated by the performance of the UK bond and equity markets in the last three months of 2002. As equities climbed higher in October and November, bond prices fell back, while in December, bond prices rose as equity market strength faded.
We believe this divergence between equity and bond market performance will be vital to achieving positive returns over the coming year.
While bonds provide much of the income offered by cautious managed funds, equities can also contribute. The UK equity market is one of the few that pays dividends and continuation of this process will ensure a relatively secure return can be provided via the yield, an attractive commodity in a world of lower returns.
Companies that can continue to pay dividends are therefore very much in favour with investors and it is no surprise sectors such as utilities and tobacco have outshone the wider market for much of past year.
Part of these sectors' outperformance was derived from growth investors searching for earnings per share growth. As a result, these sectors became relatively fully valued. Because of this, we believe cautious managed funds may have to look elsewhere for their future performance.
With other investors willing buyers of the cautious fund's stocks after they have risen, the fund can begin to target sectors that are no longer fully valued, such as telecoms and information technology hardware, media and pharmaceuticals, as well as recovery plays in the insurance, capital goods and transport industries.
Although the UK economy has proved relatively resilient, the economic outlook worldwide is still anything but clear and geopolitical tensions remain a significant factor. Until a more positive earnings environment emerges, investors will continue to search for a balanced investment proposition that offers a lower-risk strategy, a positive driver for the cautious managed sector.
Ability to switch into bonds offers potential
UK economy has proved resilient.
Investors seeking lower-risk investments.
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