Do 'safe' investments exist?

Professional Adviser asks industry experts if there are such things as risk-free investments.

MEERA PATEL, SENIOR ANALYST AT HARGREAVES LANSDOWN

The word safe should not be used synonymously with investment as it generally suggests that investors will not lose any money. I’m afraid that this is not always possible.

Look at corporate bonds, for example. Who would have thought that the higher-rated bonds could have lost 40% or 50% of their value in 2008? Prior to that, they were considered to be relatively cautious investments.

Even gilts, which are considered to be cautious, may see a fall in their capital values over the next few years if inflation persists and interest rates rise, so I can’t see how these can even be called safe.

I think investors should look at it from the other way in terms of what growth do they expect to receive from an investment and what level of risk are they prepared to take, and this should form a foundation for better investment decisions.

In this day and age, it is difficult to get any form of respectable return without taking risk, so investors must be realistic with the types of returns they expect.

PATRICK CONNOLLY CFP, HEAD OF COMMUNICATIONS AT AWD CHASE DE VERE

A ‘safe investment’ may exist in somebody’s perception, but is far more difficult to find in reality.

Anything where the price is in part determined by demand and supply can fall in value and even seemingly strong and secure banks and even governments can potentially fail.

You would expect to be pretty safe by investing in savings accounts with mainstream banks and building societies below the Financial Services Compensation Scheme (FSCS) limits, or in many of the products offered by National Savings & Investments (NS&I), which are backed by the government.

However, there is a price to pay for this safety in terms of low returns which mean that even if the investment is strongly protected in absolute terms it probably won’t be in real terms, especially with inflation at current levels.

The one safe mainstream investment, Index-Linked Savings Certificates offered by NS&I, proved too popular and have sadly been withdrawn.

Rather than try to find a safe investment, the best approach for advisers is to look at the level of security of different asset classes and investments, the potential for growth and capital loss, and match these alongside the circumstances, objectives and risk profile of individual investors.

DAVID NORMAN, CEO OF TCF INVESTMENT

Safe means ‘free from danger or harm’, so is there an investment free from all dangers? On the whole, investments face a range of possible dangers: inflation (danger that spending power reduces); volatility (the ups and downs of markets); credit (the risk of default); fraud (ie, Madoff); complexity (lack of understanding); costs (returns are eaten by charges); and expectation (the investor feels misled).

When looking at broad investment types, there are some risks that are more specific to each of these: equity volatility; cash inflation; volatility and liquidity in property; credit and inflation in bonds; and complexity and costs in hedge funds (and occasional fraud). For UCITs and passive funds, some or if not all of these risks can apply. This poses the question: Can there be any investment that is free from all harm?

There is perhaps one over-arching harm that can be mitigated: expectation. This involves advisers educating customers so that they really understand the risks and rewards of investment. Such advice includes: how an investor’s own biases could cause them ‘self harm’ and explaining how to use risk and time and sensible assumptions. This will then allow the adviser to deliver solutions that will meet expectations.

So, it seems advice may be the only safe form of investment: houses are sadly not!

CHRIS BECKETT, HEAD OF RESEARCH AT QUILTER

In a word, no. Every investment carries risk but some risks are more obvious than others.  Investment managers should be aware of all the risks inherent in an investment and construct portfolios to manage those risks for the client.

Bank deposits in the investor’s currency are generally seen as a low-risk investment, with no capital volatility, but the past few years have shown us that no bank is completely safe in extreme circumstances. There is always a small risk that the bank will not be able to repay the money when required.

Until recently, sovereign bonds were referred to as risk-free assets. However, even with government guarantees, investors are still exposed to risk. A UK-based investor buying a gilt can be pretty certain the government will repay the nominal amount of the bond at its maturity. What is not certain is what that nominal amount will be able to purchase in the future.

Real assets, equities and property should hold their relative value over the long term and can be seen as a safer investment for many investors. By preserving their long-term purchasing power, investors expose themselves to capital and income volatility. All investments contain risks, but they can be managed.

DARIUS MCDERMOTT, MANAGING DIRECTOR OF CHELSEA FINANCIAL SERVICES

2008 was an alarm clock call to advisers. Before the credit crunch there was a cosy instituted way to think of risk: that it could be mitigated merely by shifting allocations of cash, bonds and equities within a portfolio.

The theory was strengthened by historical evidence that showed equities and bonds were rarely simultaneously losing money. This perception prevailed in the favourable conditions of the bull market that followed the dot.com crash.

A rising market can blind even the most disciplined of advisers to the realities of risk. Yet, in 2008, the seismic economic events that followed the toppling of Lehmans made the traditional management of market risk look very shaky. All major assets classes bombed: equities, as well as bonds. In the IMA Cautious sector, the average fund lost 16.1%.

Yet there were funds that managed to protect capital well during 2008. A number of multi-asset funds, which we had been promoting in the years prior to the market crash, actually made money, including Miton Special Situations. Its manager had taken positions in gilts and currency in anticipation of a market fall. This is because they take a broader view, looking at more asset classes to achieve a portfolio of uncorrelated asset classes.

A number of absolute return funds also held up well, including BlackRock UK Alpha. While some investors may not like the idea of derivatives, they can certainly reduce portfolio risk. I would not say there is a market-based investment that can entirely negate risk, but there are a raft of new products that can limit capital losses in periods of extraordinary volatility. The use of derivatives and higher charging is the trade-off.