Over the next few months we will be running a series of Fund in Focus blogs, where we examine some of the top funds on the market across a range of different providers. The logic behind this is to give our clients an insight into the different types of funds on offer and why we recommend such funds to certain clients. In anticipation of this we have taken a general view of two different types of funds, namely ‘Risk-Based Funds’ and ‘Static Funds’.
At Metis Ireland we have been advising our clients to switch their investments into risk-based diversified portfolios where possible. The idea of a risk-based portfolio is that an investment manager will decide on a certain range of risk that they are willing to take with a fund. Then they will select and manage the assets in the fund to ensure targeted volatility remains within agreed parameters. For example the volatility range might be 5% to 10%. They will then manage the fund to make sure that they are getting a return within this level of volatility when markets are rising or falling.
So why are these risk portfolios becoming so popular? Well the main reason is that investors now have a greater understanding of what is meant when we say “the downside” i.e. the amount you could potentially lose if markets do not perform as expected. Take for example any static equity fund. This fund can be invested almost 100% in equities (stocks and shares). At present we are in year 6 of a bull market, which means equities have made gains each year during that period. Equity investors have had a great time and have made some serious gains.
The problem arises when markets don’t perform as investors want them to, for example during the Financial Crisis of 2007/2008. In a relatively short period of time markets crashed by over 40%. Had your investments not been diversified at that time and you only held equity funds, you would have taken a serious hit. Having your money invested in a ‘Static Fund’ scenario means that the Fund Manager cannot transfer out of equities to alleviate the drop in value. The path to parity in a recovery is then even longer, as you clamber back up in value. For example, if you have €1000 invested and you lose 40% of it, you are left with €600. If your money recovers by 40% from its low point, you are only back up to €840. From the low point of €600, your money actually needs to grow by more than 65% just to break even.
The point of the above example is to show that it is best to avoid large fluctuations in investment. A more measured approach where a fund targets more modest gains, but also focuses on more protection against the “downside”, will generally provide more favourable returns over the long term. Time NOT timing is the most important factor when investing money, along with diversification. In fact a recent study showed that when people were asked about what amount of their investment they would be willing to lose in order to target a certain return, the vast majority of respondents said 10%. From the low risk investor to the high risk investor, the maximum that people were willing to lose was 10%. As we now know, anyone invested in poorly diversified equity fund is at risk of losing far more than 10%.
Of course the ideal solution would be to know when markets are going to rise and when they are going to fall. That way you could maximise your gains when markets are soaring and minimise losses when markets are plummeting. Unfortunately, the truth is that no one knows when markets will rise or fall. As we say in Metis Ireland, trying to time the market is “Mission Impossible”. This is why we have been recommending funds like MyFolio, Pathway and iFunds etc. to our clients. These funds are rebalanced on a regular basis, so that they stay within their assigned risk bracket. Rebalancing is a very important aspect of ‘Risk-Based Funds’. Let’s say your fund is invested 50% in equities to start with. If these equities continue to grow while the other assets in your fund don’t, these equities could soon make up a much larger portion of your fund and would therefore make your fund a lot more risky than you agreed when you initially invested.
If you are concerned about the type of funds you are invested in or want to know more about Risk-Based Funds, then please call us to arrange a one-to-one meeting with one of our Directors.
By Cian Callaghan Financial Planner & Karl Daly Director
Metis Ireland Ltd t/a Metis Ireland is regulated by the Central Bank of Ireland. All content provided in these blog posts is intended for information purposes only and should not be interpreted as financial advice. You should always engage the services of a fully qualified independent financial adviser before entering any financial contract. Metis Ireland Ltd t/a Metis Ireland will not be held responsible for any actions taken as a result of reading these blog posts.