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Low-risk alternatives to sitting on cash

Some defensive (but not risk-free) fund options
April 4, 2022
  • With inflation eroding the real value of cash, investors could consider some lower-risk fund options
  • Absolute return and bond funds can be suitable options

Cash is king, except when it isn’t. Seen as the only truly safe option for investors looking to park their money to one side, cash can be expected to wither in value for as long as inflation remains at elevated levels. That poses a dilemma for investors who dislike risk but still wish to shelter their wealth.

Some investors are calling time on cash for now. While the figures could be skewed by the decisions of a few big institutional names, Morningstar notes that European investors dragged a net $43.3bn (£33bn) out of so-called money market funds in February, making it the fourth worst month for the asset class since the research provider starting collecting European fund flow data in 2007. Seeing wave after wave of alarming inflation reports, UK investors may well be tempted to do something similar.

A major problem is that there is no such thing as a risk-free alternative to cash, and those who keep some money to one side for emergencies might need to ride out the storm.

Justin Modray, director at Candid Financial Advice, says: “I would be wary of holding anything but cash for rainy day monies. Unfortunately, safe funds don’t exist – there are some that offer some form of protection, but they are usually flawed in so far as there are no guarantees and returns often struggle to beat cash after charges. In the current climate fixed interest, even short-dated, doesn’t feel particularly safe due to the impact of soaring inflation.”

Ben Kumar, senior investment strategist at 7IM, echoes some of these concerns. “There is no magic fund out there. There are funds that can moderate the risk of the equity portion you’re holding, but you’re just dialling it down,” he says.

Having said that, certain funds offer a more defensive approach, something that may appeal to investors who have run relatively high cash levels and can put some of that to work without risking their rainy day funds. As last year’s Lessons from the Portfolio Clinic feature illustrated, even experienced investors can end up running substantial allocations to cash. They may wish to use some of that more productively.

 

Cautiously does it

As Modray highlights, bonds look vulnerable in a time of inflation and rising interest rates. But some professional investors argue that more flexible, defensively minded bond portfolios still have a role to play in portfolios.

Darius McDermott, managing director at Chelsea Financial Services, certainly echoes this sentiment. “We don’t like fixed income but there are some ways to have fixed income exposure,” he says.

He highlights two absolute return bond funds, TwentyFour Absolute Return Credit (LU1273680238) and Artemis Target Return Bond (GB00BJXPPH66). The TwentyFour fund looks to deliver a positive absolute return over a three-year period by “keeping a modest level of volatility, while respecting risk diversification”. The Artemis fund has a similar objective, with its investment team seeking a positive net return of at least 2.5 per cent above the Bank of England base rate on an annualised basis over three-year periods. The funds also offer a degree of diversification and a preference for some niche bond sub-sectors. Both have recently had big allocations to financial debt, with limited use of government bonds.

It should also be noted some have grown more upbeat on some conventional bonds on the back of a recent sell-off and the resultant jump in yields. Some suggest that yields on the likes of short-dated investment grade bonds, for one, look much more appealing now.

David Appleton, senior investment manager for risk-managed funds at Brooks Macdonald, notes: "Following this correction to bond prices to reflect higher interest rate expectations, the yields available to investors from a wide range of fixed income investments have risen materially, significantly improving the risk-adjusted returns."

While certainly not immune to a further sell-off for bonds, such yields may in fact now offer a cushion against further volatility.

Other funds with a defensive remit may give a better experience than sitting in cash, even if they have struggled in the short term. The broader absolute return sector has an extremely patchy track record, but some lower-risk funds have generally tended to defend savings over time. One lower-risk option is SVS Church House Tenax Absolute Return Strategies (GB00BNBNRF27).

At the end of 2021 the fund had just shy of 40 per cent of its assets in floating rate notes, which have variable income payments linked to interest rates. The fund's managers noted at the end of last year that they had been lowering the exposure to fixed interest, which made up around a third of the portfolio at the time, and upping the floating rate exposure as a way of reducing interest rate risk.

There are very few other absolute return funds that have shown much consistency, but one name that has tended to attract praise on this front is Janus Henderson Absolute Return (GB00B5KKCX12). While it has been a fairly steady performer, this fund may sit higher up the risk scale than other options, given its long/short equity approach. The fund takes a global approach, although the UK and US made up the bulk of the portfolio at the end of February.

We highlighted earlier that no risk-free alternative to cash exists, and that is amply demonstrated by our chart. While holding up relatively well in the medium term, all of the options highlighted above have run into trouble recently, even if proving much more defensive than some equity funds. There is also a risk that such funds fail to completely keep up with inflation in the shorter term, although they are still be a better option than sitting on cash.

Other options involve embracing a higher level of risk. McDermott points to equity funds whose constituents should command a good level of pricing power, such as Fundsmith Equity (GB00B41YBW71). This fund has certainly had a painful 2022 so far.

McDermott also points to property funds as an option, although the protection offered comes with the risk of greater volatility and at a price. Take Supermarket Income REIT (SUPR), which seems to be a steady and high-yielding name, but recently commanded a chunky share price premium of more than 13 per cent versus the value of underlying assets. Mary McDougall explores the pros and cons of real assets as an inflation hedge elsewhere in our inflation special issue.