In our first article we looked at some of the broader investment challenges facing ARF investors. This week we will start to explore the various types of ARF funds that are available.
The good and bad news is that there are literally thousands of funds available to choose from.
However, it is possible to group certain types of funds together in order to filter them into something approaching a digestible format.
I have categorized them as follows:
- Cash & Deposit Based
- Government and Corporate Bonds
- Commercial Property
- Equities
- Commodities and Precious Metals
- Absolute Return
- Multi Asset
- Capital Secure Funds
- Cash & Deposit Based Funds – no surprise here, these types of funds invest only in cash and deposit based instruments. Such funds offer the greatest level of security in that they are typically the lowest risk funds available, so you won’t get any nasty surprises. The problem is that cash and deposit based funds currently offer very little, if any, investment return, and in many cases they will not ever cover inflation and the annual fee on your ARF investment.
- Government and Corporate Bond Funds – government and corporate bonds are pretty straight forward. For example, the Irish Government or a major multi-national company decides it needs to raise 1 billion euro. They borrow money from investors with a promise to pay an annual income to investors of 1% and also a promise to repay the 1 billion in 10 years’ time. A bond is essentially an IOU with an annual income. The bond holder can sell the IOU if they wish to another investor. A bond fund then is just a collection of lots of different bonds held in a very large fund. With deposits rates so low, Bond funds have been seen in recent years as the next best / lowest risk option. The problem here is that an environment in which interest rates are rising or are expected to rise can lead to volatility in bond funds. We are already entering a phase of rising interest rates in the US with the real prospect of rising interest rates in the EU in the coming 12-18 months. This may present challenges bad for most bond funds.
- Commercial Property Funds – most funds offered to ARF investors are commercial property funds (Office, Retail and Industrial) based in Ireland or the UK. Irish Property Funds have been performing very well over the past 5 years, coming off the back of falls in value of circa 50% before that. UK property funds have started to wobble in recent months due to Brexit. Any property fund is essentially a collection of commercial property held in a single fund. It makes money when rent is paid by tenants and also by increasing property prices. Property funds work very well in a rising market but in a falling market they are possibly the worst type of fund to be invested in. This is due to the nature of the assets held. If for example the stock market starts to fall in value, you can always sell your shares at a moments notice. Property funds are different. If a substantial number of investors want to exit a property fund at the same time, there may not be enough cash held in the fund to allow all investors to exit. The property fund managers then must sell a property to raise more cash to allow investors out of the fund. Selling a property in a falling market takes time and the sale price will be compromised. It may take 6 months to sell a property so by the time it is sold investors in the fund will have seen a reduction in value of the fund.
- Equities – equity or stock market based funds are plentiful and diverse. They range from equity funds that focus on a geographic region, for example US Equities, to funds that focus on an industry, for example ‘Green Energy’. Some would be considered riskier than others but they all have one thing in common – they have the potential to make and lose a lot of money in a short space of time, but almost all do and will produce a positive investment return over the long term. In fact, it is true to say that ARF investors seeking to make investment returns which would at least cover their annual fee, and inflation, will have to have some degree of exposure to equity based funds.
- Commodities and Precious Metals – gold, oil, iron, grain and more. If you fancy a speculative gamble you might want to add some of these funds to your ARF portfolio. However, there are times when the argument for using such funds can be quite compelling. For example the price of oil fell in recent years from €100 per barrel all the way down to €40. It was probably a safe assumption that investing in oil based funds at €40 per barrel was a reasonable call as the price of oil was most likely to move upwards from that very low point (which is exactly what has happen over the past 18 months).
Next week I will look at the remaining fund types which are in essence composites of the above and are designed to offer ARF investors the chance to reduce the volatility inherent in some of the funds we have already explored.
- Absolute Return
- Multi Asset
- Capital Secure Funds
Michael Coburn BBS, QFA, FLIA, LCOI, RPA, SIA
Any questions, call Joanne or Michael today on 053 9170507 or email jfenelon@arfireland.ie