The financial-market meltdown last week sparked an unprecedented flight to
safety, with government bonds and gold soaring and National Savings &
Investments (NS&I) taking millions of savers’ cash.
The chaos exposed the risks inherent in some “safe” products, though, with
thousands of British investors having poured their money into products sold
by crisis-hit US insurer AIG, or underwritten by bankrupt Lehman Brothers.
The firms insist British investors will get their money back, but the
tumultuous week — in which the FTSE 100 fell below the 5,000 mark for the
first time since June 2005, only to post its biggest daily gain in its
24-year history on Friday — has nevertheless left savers asking if there is
anywhere to hide.
Here, we look at supposed “safe havens” — and whether they live up to that
name.
PROTECTED PRODUCTS
Guaranteed equity bonds are widely sold in downturns as they offer access to
the stock market and promise to return at least 100% of capital at the end
of the term. The trade-off is that you get only a portion of any
stock-market growth.
High income bonds pay a high return, as their name suggest, and offer some
protection as long as the index doesn’t fall by more than a certain amount.
However, the guarantees on both products are provided by investment banks —
those that came under pressure last week.
“You really have to look at how the product is structured and who’s providing
the underlying security,” said Justine Fearns at AWD Chase de Vere.
ABSOLUTE RETURN FUNDS
Absolute return funds — the retail sector’s answer to hedge funds — aim to
make money in any market conditions, and 14 such unit trusts and open-ended
investment companies are in positive territory over the past year, despite
the slide.
They invest not only in shares, bonds and cash, but also property and hedge
funds, and can use derivatives — specialised products that allow managers to
make money when asset prices fall.
The practice, known as shorting, has worked in investors’ favour over the past
12 months, but the Financial Services Authority (FSA) last week banned new
short positions in financial firms for 120 days.
Darius McDermott at adviser Chelsea Financial Services said it was a
short-term setback. “Absolute return funds have a lot of other areas to look
at and can keep existing short positions if they want,” he said.
Ruffer European is the top-performing absolute return fund in the year to
date, up 10.5%. Another three Ruffer funds feature in the top 10, as do
Threadneedle Absolute Return Bond (up 9.1%), Black Rock UK Absolute Alpha
(up 6.8%) and Societe Generale Total Return Bond (up 5.6%).
CAUTIOUS MANAGED FUNDS
Cautious managed funds have protected investors from some market falls, but
have still lost an average 6.4% in the year to the end of July, the latest
Investment Management Association data show.
These funds must maintain at least 30% holdings in cash and fixed interest,
and equities are limited to a maximum of 60%.
Ruffer Total Return fund tops the tables over one year, with a rise of 9.4%
after benefiting from overseas assets — particularly a 20% holding in Swiss
bonds and 11% in Japanese equities.
Arch Cru’s Investment Portfolio and Income funds take second and third place,
up 7.1% and 6.3% respectively, but these invest in private-equity and
structured investments — far from a risk-averse play.
“Investors have to be careful and need to look under the bonnet as these more
esoteric assets lack transparency,” said Meera Patel at the adviser
Hargreaves Lansdown.
Patel favours JP Morgan Cautious Total Return fund, up 1.4% on the year. At
present it has 16% in cash, while 10% of the fund’s assets are in short
index positions.
MONEY MARKET FUNDS
These mutual funds invest in short-term debt, such as government securities,
certificates of deposit and other cash-like securities. They aim to preserve
capital and pay modest dividends.
Until recently, they were among the few places investors could put their cash
and sleep peacefully. However, the Reserve Primary Fund, the oldest US money
market fund, said last week customers’ shares were worth only 97 cents of
each dollar a share they had invested. In Wall Street parlance, it “broke
the buck” — a rare occurrence.
In the UK, the Threadneedle UK Money Securities fund, one of the biggest with
£377m invested, has lost 2.9% in the past year, compared with a sector rise
of 3.4%. Other funds have delivered rosy returns, though. Pension savers in
HSBC’s FSAVC Money Market fund have made 11% over 12 months, while
Fidelity's £45m Moneybuilder Cash Isa is up 5.5%.
GOLD
Gold has whipsawed recently. It fell 25% from a peak of over $1,000 an ounce
in March to $755 early last week, but surged on Wednesday to $866, as
investors fled to safety.
The $90 gain was a record one-day increase in absolute dollar terms and saw
gold hit a near six-week high. It closed the week at $832.
Capital Economics believes bullion has largely become a play on the dollar,
and chief international economist Julian Jessop expects the price to fall.
“Admittedly, the still-high risk of a financial-sector meltdown will provide
some support for gold, but the most likely outcome is a prolonged period of
weak global growth, low or even negative inflation and a gradually
recovering dollar, with gold remaining on track to reach $700 soon,” he said.
If you still want to get in, Gold Bullion Securities (GBS) tracks the price of
gold. Each GBS share represents one tenth of an ounce of gold and is backed
by bullion held in HSBC vaults. The value of the shares should rise roughly
in line with the price of the precious metal, after charges of 0.4% a year
and dealing costs.
CORPORATE BONDS
The collapse of Lehman has hit some UK corporate bond funds. AXA Sterling
Corporate Bond fund, F&C Strategic Bond and Extra Income funds, and Old
Mutual Dynamic Bond are among those exposed.
However, with corporate bonds — even non-financial ones — yielding around 7%,
long-term investors are advised to lock in.
“When you consider that the long-term return on equities is typically 8%-9%,
it seems absurd not to lock in some yields at these levels on quality
corporate bonds,” said Nigel Parsons at broker Bestinvest.
BT has a 2016 bond, rated BBB+, at present yielding 6.65%; AAA-rated General
Electric bonds, maturing between the end of this year and 2037, give a
typical gross yield of 6.5%; Tesco has an A-rated 2019 bond yielding 6.4%;
and National Grid’s 2012 A-rated bond is yielding 5.9%.
GOVERNMENT-BACKED ASSETS
Government bonds, gilts, are 100% secure — no government has defaulted on
these since they were introduced in 1693.
“The counterparty is the government and is therefore as safe as you can get,”
said Clem Chambers at Advfn. Capital return on redemption is fixed, with
yields on UK 10-year gilts running at 4.5%. Gains on directly held gilts are
free of capital gains.
Money in the Treasury-backed NS&I — which offers savings certificates, cash
Isas, guaranteed growth and income bonds, and runs premium bonds — is fully
guaranteed by the government, as are deposits in government-owned Northern
Rock.
NS&I cut rates on new fixed-rate investments by up to 0.75 percentage points
last week, after a fall in gilt yields, but still pays 2.95% on its tax-free
savings certificates — equal to 4.92% for a higher-rate taxpayer and 3.69%
at the basic rate. It also pays RPI, now at 5%, plus 1% on its index-linked
savings certificates. That is equal to a return of 10% for a higher-rate
taxpayer.
CASH
Rates on fixed-rate bonds have started to fall, as interest-rate expectations
come off. There were more than 30 changes to fixed- rate bonds last week,
with providers withdrawing products or decreasing rates, said the comparison
site Moneyfacts.co.uk .
Providers with an overseas parent company offer the top rates and, as they are
registered by the FSA, deposits are covered by the Financial Services
Compensation Scheme.
The UK arm of the Indian bank ICICI pays 7.2%, Nigerian-owned FirstSave 7.1%
and Iceland’s Icesave 7.06%, all over one year and on deposits of £1,000 or
more.
