Shrewd intermediaries will understand the attitude their clients have to risk and suggest products to suit, writes Mike Mumford
Look back at the stock market over the past few years and ask any commentator to describe it with one word. Many would probably use volatile, some might use challenging, others may use difficult, and they would all be right. Investors don't, as a rule, like these types of words. Advisers are not too keen on them either as it involves having to explain what they might mean to a client. And at the end of the day, the client wants the best possible return for the lowest possible risk.
Risk: to expose to danger, or possible loss. The dictionary definition is not one that you might consider using in this stark form although advisers are obliged to define the client's attitude to risk, which is where it can start to get interesting.
The client's attitude to risk will be a function of time, how long they wish to invest for, how old they are, what they currently have invested, the purpose of their investment and many other factors. For one person, a reasonable level of risk will be a balanced portfolio of global equities while the next person may throw their hands up in horror and consider equities too risky to contemplate.
So what are the main investments that advisers might consider for different clients in the low risk arena?
Bank and Building Society deposit accounts are the usual safe haven for people looking for guaranteed low-risk investments. Current instant access accounts will pay around 2% per annum, just about keeping up with inflation. These are certainly low risk ' no one has lost money investing in a building society for over 100 years ' but 2% just does not sound that great. If you have a bit more to invest and are prepared to lock it away for a period of time, to provide an income for example, then 5%+ per annum gross is achievable. Although for many investors who can recall deposit rates in double figures, even 5% can seem a bit measly.
Investors looking for a bit more income and some capital growth need to look beyond deposit accounts to stock market linked investments. The two types of investment usually next in line on advisers' lists are with-profit bonds and distribution bonds.
If the charts in the box on the top left were shown to a group of advisers without the titles, and they were asked to select the less risky of the two, it is likely that they would select the one on the left.
Yet sales of with-profits bonds outstrip sales of distribution bonds by 10 to one. Of course, the reason is obvious. Distribution bonds offer a lower exposure to equities and play on the interaction of equities and gilts (including conventional, index linked and some funds with property) supporting one another. But they do not offer guarantees. They are subject to the movements of the stock market without smoothing.
On the other hand, with-profits bonds have the smoothing effect of regular bonuses being added and not taken away. A major part of providers' marketing campaigns is the financial strength of the with-profits fund and the level of equity exposure backing the underlying investment.
Observers are already looking at with-profit bonds and questioning how bonus rates can be maintained if the return on equities in recent years has been reducing. Marketing departments across the land point to history demonstrating that returns on equities have beaten returns on gilts more often than not. The Barclays Capital survey, which goes back to 1899, supports this and concludes that the longer investors are able to hold shares, the less risky they become.
Market ebb and flow
It is as difficult as ever for advisers to pick funds that will perform for their client in the future. Many will look at the past performance at the time of recommendation and satisfy their compliance by citing this as back up for the recommendation. For most advisers, it should be possible to introduce another factor to consider at this stage.
Markets will ebb and flow with different sectors and stocks coming in and out of fashion. It is a brave person who attempts to pick the next rising star. Perhaps the key is to look at the consistency of the performance over the longer term. Investing with a fund manager who has a track record of consistently beating the peer group and providing above-average performance is a way of providing the 'safe pair of hands' that clients and advisers often seek.
The chart on the bottom left shows the rolling five-year performance of the AXA Sun Life distribution fund compared to its rolling one-year performance. Looking at the one-year performance at any period over the last two years would not be the most compelling of stories. However, five-year performance at any time over the past two years has been top quartile. The consistency of the medium-term performance demonstrates a safe pair of hands, a fund manager that is achieving the objectives of the fund and a fund that is not going to provide too many surprises for clients and advisers alike. And that, for some, will provide a good balance of achieving a return in a low-risk environment.
It is possible to spend a lot of time analysing and projecting future returns on funds in a variety of economic environments, which may or may not prove to be accurate. But ultimately, the adviser and client will only find out the value of this when they come to cash the investment in.
In all this though, there can be no substitute for knowing what the client actually means by low risk and ascertaining if that is what they really need to achieve their objectives. The saying 'one man's meat is another man's poison' is definitely one to bear in mind in these discussions
The longer investors can hold shares, the less risky they become.
Instant access accounts will pay around 2% per annum.
Sales of with-profits bonds outstrip sales of distribution bonds by 10 to one.
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