A few days ago, I was reviewing my investment portfolio to see how elements of it have performed in recent months. The task takes quite a few hours and I only managed to work my way through a few funds before a glass of wine beckoned.
But the good news was that, on the whole, things have not been so bad. There are one or two underperforming duds, but, on the whole, the portfolio created and maintained for me by my IFA a few years back has stood the test of time reasonably well.
Part of my relative confidence is that after 20 years honed by long conversations with IFAs and fund managers about various aspects of the market, I have a reasonable understanding of the balance between risk and reward. I am prepared to accept the possibility of fairly significant losses in order to achieve my personal desired outcome.
For millions of people, the situation is nowhere near as clear.
They do not have either the time or the inclination to make decisions based on a clear understanding of risk and reward. They leave decisions like that to their financial advisers or, if they don’t understand the value of an IFA, to their bank.
The result has been that, over the years, the majority of investors end up being told to place their money into some of the most appalling funds.
They become victims either of various fashion cycles, such as Europe in the mid-to-late 1990s or the high-tech sector at the start of the Noughties.
Each time, persuasive arguments are put forward as to why a particular sector needs to form part of a portfolio and each time, after a year or two, the punters get burned.
The net effect of all this is that investors become incredibly suspicious about the investment market, forcing fund managers, salespeople and advisers to come up with inventive names for funds to persuade them their money is safe and they are not really taking a risk at all.
Hence the massive concentration of funds within IMA sectors labelled cautious or balanced. Fund managers know that people like to hear these words being used in connection with their portfolios. It adds a sense of reassurance even though, in many cases, such faith is misleading.
It is in that context that we need to look at the launch a few days ago of RBS’s new volatility controlled cautious and balanced funds. The cautious fund aims to never exceed 10 per cent annual volatility and the balanced fund aims to maintain annual volatility between 10 and 15 per cent.
RBS claims to have back-tested the two funds’ strategies over the past 10 years and the average annual volatility would not have exceeded 6.8 per cent, with an average nearer to 5 per cent. The corresponding figures for the balanced fund are 13.1 and 11.5 per cent. By contrast, many other funds in the same sector had volatility far in excess of this, double or triple in a number of cases.
It would be easy to be sceptical of RBS’s claims. After all, banks do not exactly have a good name when it comes to the way they design or market their products.
It could also be the case, as Seven Investment Management founder Justin Urquhart Stewart argues, that a 54 per cent holding in equities for RBS’s cautious product, while within IMA guidelines for the sector, is still too risky. A cautious investment strategy should really only have about a third in equities.
In addition, both products rely on swap contracts with RBS to gain exposure to the various asset classes, creating counterparty risk with the bank itself. In other words, we are supposed to believe that a bank which was bailed out by the public just two years ago is a suitable vehicle to guarantee investors’ assets.
In fairness, RBS appears to have tried to do its utmost to ensure its two new funds pose less of a risk to investors than many of the others nestling in the two IMA sectors. But we should then be asking why RBS is continuing to sell its older, non-risk managed cautious and balanced funds.
Although IFAs are right to be wary of the potential dangers posed by these two new funds – and a watching brief seems sensible for at least a year or two – the real issue is over the way that the two IMA sectors have been abused in the past decade or two.
It cannot be right that, as advisers discovered two years ago, funds like the suspended £275m Arch Cru Investment Portfolio could sit comfortably within the IMA’s cautious managed sector.
It is less the investment strategy of the funds that needs to be looked at than that the sectors they sit in are ripe for review. IFAs should be demanding the IMA acts immediately to redefine both sectors.
Nic Cicutti can be contacted at firstname.lastname@example.org