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DIY brokers' poor cash alternatives

Money market and gilt funds are not perfect replacements for cash in your portfolio
July 17, 2014

Most of the investments marketed by DIY brokers as cash alternatives are failing to protect investors' money by providing them with below-inflation returns, after fees.

Money market funds, gilt funds and individual gilts are the three main 'safe' investments that savers can use to house their cash if they don't want to risk it on the stock market. But Investors Chronicle analysis shows how, when purchased through the UK's biggest platforms, many of them provide worse returns than cash. And a number have even lost money.

Last week we reported how dire cash rates (average 0.1 per cent) in individual savings accounts (Isas) and self-invested personal pensions (Sipps) held through DIY brokers are hurting savers and pensioners. On average, investors with the UK's biggest brokers have between 8 and 15 per cent of their portfolio in cash.

Brokers admitted their cash rates were dire, but they were keen to highlight the wide range of 'cash alternative' investments that they sell instead. But a closer inspection of these products shows that on the whole, they also offer poor value to investors.

Money market funds

Money market funds are funds that are designed to produce cash-like returns. They invest mainly in cash, but they may also invest in cash-like assets such as corporate debt and gilts. They are ultra-low risk products that are used by investment managers as a short-term safe house for money they want to move out of the stock market, while they decide what to do with them next.

But the vast majority of money market funds are not considered to be a viable long-term alternative to holding cash in your portfolio. The returns on most money market funds are only marginally better than DIY brokers' measly cash rates, but after fees many investors are getting even worse returns than cash. Over one year (to 30 June 2014), six out of 20 of the money market funds available to private investors made a loss, and that's before broker fees are taken into account.

Astonishingly, after management fees (average 0.47 per cent) and platform fees (0.2-0.45 per cent) are scraped off their returns, the average money market fund bought through a big DIY broker lost money over the last year.

The best performing fund (The Marlborough Cash Trust ISIN:GB00050710) produced 0.81 per cent, while the worst (L&G Cash Trust ISIN:GB00051415) lost 0.24 per cent over the period. Meanwhile, total expense ratios (TERs) range from 0.23 per cent to 0.65 per cent.

An L&G spokesperson, said: "The L&G Cash Trust follows a simple approach to cash management, designed to diversify risk across a large number of high-quality global counterparties. The fund invests only in cash and we apply strict limits on counterparty quality and the proportion of assets that it can hold in time deposits beyond two weeks. The aim is to balance the safety our clients' need with returns from short-term cash deposits. Less conservative funds may achieve better returns, but could be prone to volatility in times of market stress."

Seth Cowburn, head of investment at Duncan Lawrie Private Bank, agrees that the quality of these funds is important as they are designed to be safe. However, he added that while money market funds can be short-term investments for someone tactically moving money out of the stock market, they should not be used as long-term investments.

Gilt funds

Another option for investors looking for a 'safe' investment that will beat cash is gilt funds, which invest mainly in UK government securities. Gilt funds invest in a range of gilts with different maturity dates, with a manager actively deciding which ones to buy and sell. This creates added risk because some gilts perform better than others during different market conditions. Over the last five years, gilt funds have thumped both cash and money market funds, returning an average 27 per cent return over the period, and 1.68 per cent over one year. However, they come with higher charges which will bite a significant chunk out of your returns, as the average TER is 0.89 per cent.

Over five years, AXA Sterling Index Linked Bond R Gross (GB00B0T9VB55) was the top-performing gilt fund with a 44.55 per cent return, while Schroder Gilt & Fixed Interest Acc Fund (GB0007647489) brought up the rear of the pack, producing 18.44 per cent over the same period.

But, despite this solid performance over the last five years, Ben Yearsley, head of investing at Charles Stanley Direct, says these fortunes are unlikely to continue. He also admits he wouldn't touch gilt funds with a barge pole. "Interest rates have been at rock bottom for five years which is why most gilt funds have done so well. But interest rates look likely to rise soon, which would spell the end of these healthy returns."

Individual gilts

Mr Yearsley says a better option is to buy individual gilts. This is because they are less risky than gilt funds because you "know exactly what you're getting". But individual gilts are traded on DIY platforms in the same way as shares (even though they are part of a completely separate market). This means, that just like shares, they incur hefty buying and selling fees.

In some cases these fees are so high they outstrip the yields on gilts all together. For example a two-year gilt is currently yielding 0.8 per cent a year, but Hargreaves Lansdown and The Share Centre charge 1 per cent to buy them, while Charles Stanley Direct charges 0.75 per cent. If you have a large sum to invest in gilts, a pounds and pence charge will work out cheaper - Fidelity is the cheapest for a one-off trade at £9.

Top 10 performing money market funds over one year available to UK private investors

Fund nameCurrent ongoing charge (%)1-yr total return (%)3-yr total return cumulative (%)5-yr total return cumulative (%)
Marlborough Cash Trust0.20.83.34.5
Wesleyan Cash00.311.6
Baillie Gifford Cash0.10.20.71.1
IP Money0.50.21.13.3
Jupiter Cash0.20.10.60.9
Henderson Money Market UT0.30.111.9
Henderson Instl Cash R Acc0.30.11.12.6
Threadneedle UK Cash Net Income 1 £ Inc0.20.10.64.5
Fidelity Gross Accumulating Cash0.40.090.51
Premier UK Money Market A Acc0.60.091.22.3
Source: Morningstar, as at 30 June 2014

Top 10 performing gilt funds over one year available to UK private investors

FundCurrent ongoing charge1-yr total return3-yr total return cumualtive5-yr total return cumulative
Royal London Index Linked Fund A0.43.821.444.5
AXA Sterling Long Gilt R Gross Acc0.83.824.233.4
Henderson Instl Long Dated-Gilt A1.23.322.231.8
AXA Sterling Index Linked Bond R Gross0.73.424.444.5
Threadneedle UK Index Linked R0.62.918.338.8
M&G Index-Linked Bond A Inc0.62.922.144.2
Scottish Widows HIFML UK Idx Link Gilt 11218.339.9
Threadneedle UK Fixed Interest R0.61.913.525.1
Henderson Idx Lnkd Bd A Inc1.11.620.842.7
Invesco Gilt A0.81.612.520.9
Souce: Morningstar, as at 30 June 2014