Preserving your wealth in a falling market

Australian Financial Review, April 2008

There’s a TV ad doing the rounds at the moment for a global bank, which includes this line: “some think growth opportunity, we think wealth preservation.” Lately, it’s been a useful attitude, because the last six months have been all about preserving the wealth you’ve already got rather than worrying about making more.

It has been a time when low risk assets that chug along reliably have been the way to go. It won’t stay that way: sooner or later (and some think that time is already here) it will pay to go for the riskier and more exotic assets whose valuations have been so badly hit in recent months. But for many people, what they really want is security.

Investment offers lots of options to do this, from leaving the cash in the bank to investing in complex capital protected structured notes, but in this feature we limit our field to mutual funds. We look at five different approaches to preserving wealth, and look in detail at funds that have attempted those approaches. These are the methods that should – in theory – leave your investments at least holding their own despite the storms in the markets, and should in turn leave you with more to put to work when you’re convinced the worst is over and it’s time to reinvest.  

CASH FUNDS

Macquarie Cash Management Trust

The simplest investment you can make to protect your wealth is to put everything in cash. Cash isn’t going to make you a fortune – it’ll barely beat inflation – but it’s also not going to crash around your ears.

You can invest in cash just by putting your money in the bank: internet accounts like ING Direct, which piggy back off your existing account, now offer 6.9%, with no restrictions on withdrawal, and term deposits can offer as much as 8% for a year. But there are managed funds too which put your money into cash, generally known as cash management trusts.

The biggest of these is the Macquarie Cash Management Trust, which had A$17.6 billion under management in early 2008 according to fund researcher Morningstar, making it the largest managed fund in Australia. Like most funds of its type, this puts your cash into money market investments, which you would need hundreds of thousands of dollars to invest in as an individual. Most of the underlying investments are short-term, with the longest dated being 90 days.

So why bother with a fund instead of putting it in the bank? A fund like this will generally offer a pretty good return for a low minimum investment – in Macquarie’s case, $5000. It’s as well protected as any Australian bank, with a AAAm rating from Standard & Poor’s, the highest possible rating for a cash management trust. They tend to offer the same benefits of internet access and telephone banking as any bank account and, depending on the product, offer swift redemption when you need the funds. But they really stand out as the hub of a self managed super fund, and increasingly are set up with that in mind with consolidated record keeping and easy transfers into other linked investments. These elements can be beneficial outside of a super fund too, and can be linked for automatic settlement of share trading, for example.

Beyond that, though, it’s still very much work shopping around deposit accounts if you like the idea of cash. And remember to factor in the impact of the fee (1.1% on the Macquarie product) on working out your end return. Smart Money recently asked one of the most highly regarded equity fund managers in Australia where he was planning to put his money in this volatile environment. “Well, term deposits are looking pretty good,” he said.

In terms of returns, on Morningstar’s numbers the Macquarie fund has returned 5.75% in the year to February 29, which is pretty much the middle of the pack (Morningstar monitors 70 such investment trusts with returns ranging from 6.88% to 3.8% – the fact there is such variety in what should logically be a very predictable return is a glaring indicator that cash trusts don’t put their money in the same investments as you might think). 5.75% is, of course, well under the current interest rate from the Reserve Bank of Australia, and it’s also less than internet cash accounts, but do remember you pay tax on interest on cash in the bank.

It’s worth remembering, by the way, that cash pays a higher rate in Australia than it does in almost any other developed country worldwide.

CASH ENHANCED FUNDS

AMP Capital Managed Treasury Fund

The idea of the cash-enhanced fund is that it gives you a nice stable cash return, plus a little bit extra  by investing in some other low-risk investments. The problem is that lately, some of these low-risk investments have not enhanced returns at all, but diminished them.

One of the funds with better performance numbers is the AMP Capital Managed Treasury Fund. This invests in “prime quality bank bills and other short term securities”; on February 29 it had 43% of its money in promissory notes, 39% in negotiable certificates of deposit, 17% in floating rate notes and 1% in corporate bonds – so all fixed interest securities of one kind or another, but not quite the homogenous almost risk-free assets of a pure cash fund.

The AMP fund looks better than most, but the fact is that based on its own numbers, as of February 29 it was lagging its benchmark, the UBSWA Bank Bill Index, on every timeframe from three months back to inception. Over the last year, for example, it has returned 6.22% before tax and after fees, but the benchmark has done 6.83%. A modest difference, but one which calls the term ‘enhanced’ into question, although now’s a bad time for any fund using fixed interest investments to try to boost returns.

Data from Morningstar shows the problem. The range of returns among the 46 Australian cash enhanced funds it monitors range from 6.88% – also the top score from any mainstream cash fund – down to a 6.16% loss from the Blackrock Income fund bought through AMP. Blackrock is one of the biggest names in global funds management, and it’s in good company at the bottom of the pile: also either losing money or making a negligible amount over the same timeframe are products from Perpetual and UBS, two of the other most respected names in the business. There’s no question that when it comes to cash, funds that keep it simple have won the day over those who try to enhance over the last year.

GOLD

Select Gold Fund.

Everything has been hammered in the last six months: local stocks, global stocks, fixed income investments of every stripe, listed property. But there is one big exception: gold.

Gold is often considered a great hedge against problems in the US, and in particular against declines in the US dollar. It’s a classic flight-to-safety investment, hoarded by central banks as a haven of stability in difficult times. And it has lived up to its reputation lately, hitting all time highs and likely to cross the US$1000 an ounce mark for the first time sooner rather than later.

There are a few funds in Australia designed to give exposure to gold, and the Select Gold Fund is one that has benefited from the precious metal’s performance. Its principle mandate is to invest in the stocks of companies involved in gold or precious metals, but it does have the option to invest in bullion, or exchange-traded funds that mirror those commodities, up to 50% of the value of the fund. The underlying management is done by a group called Baker Steel, based in London, which runs US$840 million under management in the commodities sector. On February 29 its top holding was Australian: Lihir Gold.

While the fund looks good compared to most investments, it hasn’t beaten bullion, or indeed the widely-followed FTSE Gold Mines Index. Over the year to February 29, for example, the fund was up 13%, compared to 33.1% for the gold mines index and 33.9% for bullion. Over three years, its 22.9% return is closer to those indices.

So what’s the outlook for gold? There are plenty of things in its favour: flight to the metal from institutions concerned about the outlook for the USA and its currency; increased demand, particularly from markets like China and India; constrained supply in much of the world; and the hedge books of institutions like central banks. It’s already accelerated markedly so most of the good news has already been factored in to the price, but it’s a rare oasis of positive performance in a difficult global market.

Gold funds have been accompanied by a host of commodities funds, or investment products linked to commodities, some of them metals or oil, and others soft commodities such as wheat and cotton.  The Goldman Sachs JBWere Food Fund was launched in January, for example; others include the Macquarie Gateway Agriculture funds (there are two with different levels of capital protection), and the DWS Global Equity Agribusiness Fund (DWS is part of Deutsche Bank).

ABSOLUTE RETURN FUNDS

Naos Absolute Return Fund

The wonderful theory of the absolute return fund is that it should be able to deliver a return in any market environment, without being strapped to some uncompromising benchmark like the broader stock market.

The long-short fund is a common version of absolute return. It means a fund that can take long positions (meaning it invests in things in the hope that they will go up in value), or short positions (meaning it will benefit if they decline in value). A skilled manager, therefore, makes money – or at least doesn’t lose it – even when markets are falling.

The bitter truth, though, is that track records are extremely varied in this regard. It is very, very hard to be good at picking stocks that will go down as well as up, because the manager also has to get the timing right, which often has nothing to do with the underlying stocks. According to the Chicago-based Hedge Fund Research, the first three months of 2008 were the worst since the organisation began keeping records for hedge funds, with March the worst month since the collapse of Long Term Capital Management in New York in 1998. That doesn’t appear to speak of hedge funds flourishing in this newfound volatility.

One Aussie fund that has emerged reasonably intact is the Naos Absolute Return Fund. Formed in 2004, it can invest in stocks in the S&P200 index, and aims generally to have a 60% net long position, which means over the long term you would expect three fifths of the positions it takes to be long rather than short. It has lost money in the last 12 months – albeit just 0.84%, according to Morningstar – but a more relevant figure is that even after recent declines it is still up 14.24% annually in the last three  years.

In these uncertain times, a couple of attributes of funds like these may raise the hackles of bruised investors. For one thing, it can have a gross market exposure of 250% of the net asset value of the fund – that is, it can be leveraged up to two and a half times, not an especially popular arrangement at the moment. For  another, funds like this are not cheap: a management of 1.5375%, plus a performance fee of 20.5% of any return over the UBS Bank Bill Index (that is to say, cash).

The performance of Australian funds like these has been dramatically polarised through this crisis. Morningstar covers just 10 Australian long-short funds, and only seven have one-year data available up to February 29; they range from a 21.5% return (Macquarie Australian Market Neutral Fund) to a 8.56% loss (another Naos product, this time a small companies fund). The 11 global long-short funds Morningstar covers with one year numbers are still more divergent: from the CFS Wholesale Global Resources Long Short Fund at 15.53%, to the Jana Global Share Long Short Trust with a 20.85% loss, most of it in the last six months.

BONDS

EQT PIMCO Global Bond Fund

You would think, with the credit crunch, that this would have been a shocking time to be exposed to global bonds. But that’s not entirely true. Of 51 global bond funds covered by Morningstar with one year performance data, only three have lost money in the year to February 29 and only two in the last six months. Over the last year the median return is actually 6.91%, which doesn’t sound great when you can get over 7% by putting money in the bank, but remember you’d lose a chunk of that bank interest in tax. In any event, it’s not the doomsday scenario one might expect.

One fund that has kept its head well above water is the Pimco Global Bond Fund, which has a version that is sold to retail through Equity Trustees. On Morningstar numbers, it was up 8.58% in the year to February 29 after fees, and 6.67% a year over three years.

A look at its active positions on December 31 gives a few clues as to how it has done well. Relative to the Lehman Brothers Global Aggregate Bond Index, against which it measures itself, it has been heavily overweight AAA securities, the most highly rated bonds and those which naturally have weathered the storm better than anything else. Interestingly, though, it has also been modestly overweight BBB and sub-investment grade securities, which is a much harder trick to pull off: pick the wrong ones of those and you can be wiped out. It’s been underweight the bits in the middle, rated A and AA. We can also see that it has been underweight Asia, and overweight Europe; that it has held less government or semi-government bonds than the index, but more mortgages and swaps; and that much more of its paper is relatively short term, maturing in the next three years, than the index.

Bonds funds will never shoot the lights out at the best of times, and global bond funds do tend to look a little scrawny when viewed from Australia because our interest rates are so high compared to other developed markets. There’s the currency issue to consider too. But all multimanagers consider that global bonds have a key place in a balanced portfolio, and the data shows that they have done rather better than the credit crunch brouhaha might have suggested.