Low-risk ISAs

Corporate bonds? Absolute return funds? Property? There’s a wide choice of opportunities for low-risk ISA investors,
as Simon Read discovers...

ISAs & SIPPs as a private investor

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Corporate bonds? Absolute return funds? Property? There’s a wide choice of opportunities for low-risk ISA investors,
as Simon Read discovers…

Corporate bonds? Absolute return funds? Property? There’s a wide choice of opportunities for low-risk ISA investors,
as Simon Read discovers…

The concept of a low-risk investment may seem like an oxymoron, but for many people it’s the solution they seek for their annual ISA cash.

It’s understandable that anyone burned by the wildly fluctuating stock markets of recent years may want to reduce the chance of losing a big chunk of their nest egg, but choosing a fund that is marketed as low-risk could, in fact, mean taking an unnecessary risk with your savings.

Why? Because reducing the risk of an investment opportunity means cutting the potential profit. Peter McGahan, managing director of Worldwide Financial Planning, likens the process to walking the plank. ‘If you stick a length of wood on the ground and ask someone to walk across it for a tenner, they’d do it,’ he says. ‘Stick the same piece of wood across two high buildings and most would refuse. But then, if you increase the payout to £1 million, many would attempt the crossing – that’s the essence of risk versus reward.’

In short, you need to weigh up the potential return against the potential loss. The greater the return you may get, generally the higher the risk. Which means, of course, that as you reduce your risk, you also reduce your potential returns.

Saying that, there are plenty of low-risk opportunities that offer potentially decent returns. The key, says McGahan, is to decide what you mean by low risk.

‘For some people it means not taking any risk with their capital – in other words they want their money back. Others are happy to chase better returns in the knowledge that they could lose 30 to 40 per cent of their cash. Investors need to be clear in their minds about where they stand, and be sure that any funds recommended to them fit their criteria.’

A subjective matter

Most experts agree with that point. ‘It’s important to remember that risk is very subjective, and that we all have different views of what low risk constitutes,’ notes Jason Witcombe of Evolve Financial Planning. ‘You should consider what the most important risk is to you. Is it the risk of capital loss, the risk of high volatility or, perhaps, the risk of your money being eaten away by inflation over time?

‘If inflation starts to creep ahead it would be easy to argue that, particularly for a young investor, a cash ISA is not low
risk at all. I would recommend a fund supermarket or self-select ISA to allow you to use funds from a variety of managers within the same ISA rather than limiting yourself to just one fund manager. That way, you can better tailor the choice of funds to your own risk appetite.’

Adrian Lowcock, senior investment adviser at Bestinvest, also advises investors to consider what their objectives are. ‘By concentrating on low risk they should expect lower returns and, as a result, double-digit annual growth is something that should not be expected,’ he warns.

‘Lower risk doesn’t necessarily mean no exposure to equities but certainly a reduced exposure. Investors should look to aim for returns slightly better than cash, to compensate for the added risk that they have taken on.’

He tells his clients that if they are concerned about conserving their capital, they will have to sacrifice some of their potential returns for the greater security they seek. ‘It’s right for many people. Yes, they may miss out on strong rallies, but they will be protected from the big falls as well.’

The name’s bond…

One option for low-risk investors is to plump for corporate bonds, says Lowcock, but he adds that a balanced portfolio is important and that investors should look at getting some exposure to shares in their ISA. ‘We recommend Invesco Perpetual Corporate Bond [fund], which yields 4.4 per cent net, which would be a suitable investment for a low-risk investor.

‘It is also important to diversify, as putting all your eggs in one basket adds its own risks. I would therefore suggest that this fund could be mixed with exposure to some equity, such as Artemis Income, which is a more defensively positioned fund. Finally, to provide some greater diversification, investors could consider an absolute return fund such as Gartmore European Absolute Return.’

Corporate bonds and gilts put in a strong performance in 2009, but some experts think that now is the time to avoid them. Traditionally, a lower-risk choice for an ISA would lead investors to invest in a fixed interest fund with a high gilt content, but some believe that now could be precisely the wrong time to invest in such a fund.

Set for a fall?
Being at the end of quantitative easing and the continued need for high government borrowing could mean an increase in gilt yields. Some say that this could lead to a fall in gilt values. So an investment into gilts, which are traditionally viewed as being a conservative asset class, could come with a high degree of capital risk.

However, Brian Dennehy, managing director of Dennehy, Weller & Co, still thinks there is money to be made in corporate bonds. ‘Low-risk investment covers corporate bonds, property, absolute return and, arguably, cautious managed funds – although I think that too many of these underachieve, and the evidence of underperformance in autumn 2008 is not encouraging.

‘2010 is still a year of transition for the economy, and if it stalls I would not really want to be overly exposed to property – there will be time to get on board.

‘There are some decent absolute return funds, but if you want to maximise the tax-free element of an ISA, an income-orientated corporate bond fund is preferred,’ says Dennehy.

‘After a stunning period from the March 2009 low (some funds are since up 50 per cent or more), the past month or two have been a bit more sober. Having said that, there is still money to be made, and a ten per cent total return from corporate bonds is our target for 2010.’ He says the fund that has impressed him most lately is Henderson Strategic Bond.

Low risk misnomer

Ben Yearsley, investment manager at Hargreaves Lansdown, says that the words ‘low risk’ can be misleading. ‘I never like using the term low risk with any investment as it implies that you can’t lose money.’

Instead, he advises clients looking for low-risk returns to consider absolute return funds. ‘There is an ever-increasing universe of these funds to choose from now, all being managed in different ways,’ says Yearsley.

‘I think it is useful to look to invest in more than one as you often find them performing at different times. Absolute funds to consider include Cazenove UK Absolute Target, BlackRock UK Absolute Alpha and Gartmore European Absolute Return.

‘The other area to consider is more defensively positioned funds – such as Invesco Perpetual Income. However, this isn’t a low-risk fund, it is just more defensively positioned.’

He stresses that these funds are not a no-risk option: ‘You can lose money in any of these investments, and with absolute return funds you will underperform a strongly rising market.’

However, he says investors should ensure that they make use of the tax-free allowance offered through ISAs. ‘Tax rises are on the way, particularly after this year’s election, so being able to shelter £10,200 (if you are over 50) and £20,400 for couples over 50 shouldn’t be sniffed at.’

Simon Read is personal finance editor at The Independent

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