No such thing as risk free

Skerritts’ head of investments Andrew Merricks asks if there are any ‘safe’ investments out there as the eurozone hurtles towards a messy denouement.

There’s real fear out there. As the eurozone debt crisis appears to be entering some kind of final phase, we are receiving more calls from individuals genuinely concerned about preserving their capital.

Those with memories of 2008 are questioning the security of the very banks that hold their cash. The most common request at the moment seems to be for investing in something “safe”, with no risk. There is no such thing.

Cash

Normally, cash is the best risk-free asset. But apart from only being guaranteed for the first £85,000 of your money should your bank go bust (one suspects the banks and authorities themselves do not know the full extent of banks’ liabilities in the event of a European sovereign debt default, so how on Earth can we be expected to know?), we also have the problem that interest rates are significantly less than inflation.

This means the only guarantee of holding cash for long is that you lose money in real terms as inflation gnaws away at its spending power.

This does not sound risk free. So, if inflation is the worry, you simply hold your cash in index-linked gilts?

Index-linked gilts

If we knew for sure inflation was here to stay, these would be the perfect risk-free investment. But we do not. Mervyn King has continually said inflation is artificially high in the UK, and we agree with him.

The one-off VAT rise will disappear from next year’s calculations, while oil prices have subsided a little from their highs earlier this year.

Food prices also spiked earlier in 2011 so, with workers striking more to protect their jobs rather than demanding more money, wage pressure on inflation looks non-existent so the inflation rate could easily fall.

If it does, so does the return you receive from index linked gilts, but more importantly, so does your capital value as the flow into “linkers” reverses. This does not sound low risk to us. So why not hold traditional gilts?

Traditional gilts

Gilts have recently been described as “return-free risk”. This may be a little unfair, but it highlights the fact they are far from risk free.