Rachel Oliver reports on the increasing interest in guaranteed funds
While the UK investor is re-nowned to be heavily inclined towards equities, the continental European institutions are typically viewed as being more risk averse, to say the least. And the recent volatility in the world's stock markets have given them even more reason to be just that. But guaranteed funds, which have found particular success in the French, Spanish, German and Belgian retail markets are rapidly growing in popularity amongst their institutional counterparts who have discovered a method to safeguard their cash while gaining exposure to riskier markets.
Guaranteed funds use a variety of hedging techniques to maintain their constant net asset value (NAV) but contrary to their name, - and a factor which investors need to be aware of - they do not all offer total guarantees on the capital invested, according to Stephanie Méry, associate director at Standard & Poor's (S&P) in Paris.
The important point is that these products are carrying some risks - a guaranteed fund is not completely guaranteed. They are not completely safe." As a result, in a similar vain to money market funds, guaranteed funds carry different ratings - the high-er the rating, the less risk involved.
Guaranteed funds are typically guaranteed internally - within the fund - that is to say, the type of investments imply an optimum level of security and ratings agencies assess the degree of reliability of the fund in returning 100% of assets, regardless of market conditions - again, similar to that of a money market fund. But in some cases the funds are guaranteed by the fund sponsor themselves, in which case, the rating procedure takes into account their credit quality.
The majority of large banks and in-vestment houses in Europe run the funds - notable providers include Kredietbank, Banque Internationale á Luxembourg, Credit Lyonnais, Credit Agricole Indosuez Luxembourg and SBC. Méry explains the thinking behind the fund's appeal on the continent: "It is important for in-vestors to invest in a wordwide risky market and to be sure to get capital back even if the market decreases a lot, so they want to increase the risk of in-vestments without having a decrease in capital invested, and that is important for retail customers but also for insurance companies which have different regulations in each country."
She adds: "For pension_fund managers who have to manage their short term liquidity, they have to be sure that they will get back the capital in full."
Kredietbank has experienced a great deal of interest from Belgian pension funds, and is in the process of developing different 'themes' of funds which, says Stefan Duchateau, manager, investment division at Kredietbank in Brussels, has particular appeal to the pension fund investor.
"One of the popular themes that we have been playing with, is for example in the pharmaceuticals sector where we made a sector basket of 25 stocks worldwide which we gave an upward potential of 100% over the coming six years and this could be of some interest to certain pension funds. I know that pension funds are more considered to be active traders, but when you look at the highly volatile markets at the moment and when you look at the fact that you only loose very limited dividends in certain sectors, it could be good to look into for certain pension funds."
Duchateau feels that too much stress is placed on standard deviation techniques which considers both the upward and downward potential of the market as risky, an idea which he finds as "ludicrous".
He says: "What we do is take away the downward potential and keep the upward potential and the premium that you have to pay for it is approximately the dividendsthat you give up. But for very big investment coming from pension funds we are still liable to make improvements in all sorts of things."
While guaranteed funds are experiencing substantial interest in the institutional market, only a small proportion of pension fund assets are actually invested in the funds, a situation which Duchateau believes is the exact opposite of what it should be. "The idea would be to do it the other way round - to put a large chunk in the portfolio in a capital guaranteed structure, you work in a marginally higher risk level, and now everybody is diversifying, you diversify away a certain amount of risk," he explains. "All the non-systemic risk is away but you keep the systemic market risk. Now it would be an appealing idea to me to take away the market risk and then run the unsystemic risk where you want to run it - I think that's much more in tune with modern finance."
Another area where he feels pension funds need to be 'educated' concerns the area of short term and long term risk, the current opinion which he finds is that short term risk concerns overshadow the risks that lie ahead years down the line.
"When you talk to finance managers and certainly pension fund managers, they think they get the idea and then when talking about diversifying risk they always give the same arguments: 'yes but in 10 years' time, who needs capital guaranteed data?' but they are completely wrong."
He adds: "I always keep investing in stocks, even 100% in stocks, but you don't have to trust history too much, when you look into it from a statistical point of view, it means that when you apply 10% expected return and you compare it with 20% standard deviation - that's what we've had for the last 60-70 years on the stock markets - this means that you run maximum risk at about five years. So your risk in five years is higher than the risk over one year."
While the guaranteed funds are growing in popularity, ironically, it has had very little to do with the recent stock market trembles felt world-wide. If anything, it has had the re-verse effect on investors. Any product linked with the stock market has been met with a notable degree of indifference from pension fund investors, says Duchateau. But he still sees the positive side: "We have seen people be-coming more reticent to everything that is stock market linked, but in a year or so, we will be able to refer to this period and say 'well, see, everybody told you it couldn't go wrong, it did go wrong and we gave you capital guarantee.""