I’m too young to be a conservative investor.
But a couple of years ago, as the share market started to look dangerously overcooked, and given that (as a business owner) I was already carrying significant risk exposure to the economic cycle, I wanted to balance out some of the risk across my portfolio.
After many years in a KiwiSaver Growth Fund, I switched to a Conservative Fund.
It felt like a smart move at the time, but man, hindsight’s a wonderful thing.
Since making the shift, I missed the last final crazy run up of the share market and more recently I’ve only been able to watch my money go backwards, with a loss of 6.42 per cent over the past year alone.
That’s not even factoring in the impact of inflation. In “real” terms, my investment’s gone backwards even faster.
It has staggered me. And I imagine many other conservative investors will have had a similar experience. The median return on conservative funds across the New Zealand market for the year to March 2022 was a loss of 1.7 per cent. For growth funds, it was a profit of 3.6 per cent.
I’d never have thought conservative funds would convincingly under-perform higher risk funds in a bear share market. And how is it that conservative funds have even under-performed leaving money in a term deposit over the past three years?
What’s behind this poor performance?
The reason is that Fund Managers are mostly investing into bonds that pay a fixed return over the life of the bond.
This was a sure-fire strategy in a falling interest rate environment, with mark-to-market profits on bonds generating over-inflated returns.
The world has changed. Conservative funds and supposed “low-risk” bond funds have been absolutely ravaged by inflation and the change in the interest rate cycle – and with market interest rates going up, these assets are revalued at a loss. While this generates a negative return on funds, the bond will have relatively low capital risk. If a manager holds the bond to maturity it will have a positive yield – albeit a low one.
To get a good return on conservative funds is going to require a different and more active approach in the future.
Say, for example, Fund Managers had been buying floating rate bonds, like residential mortgage-backed securities. They’d be earning a yield of 1.30% over bank bills, which today would generate a return of around 3.80% with no mark-to-market losses and the securities would reprice up with the market. And what’s the risk on that? Well, credit losses on home loans held by banks over the last 12 months have been 0.001 per cent, so a very strong capital position for what you’d argue is a reasonable return.
People hunting for a low-risk way to save have had scant choice in recent years – either earn nothing in the bank, or risk negative returns in conservative managed funds. It really does hurt holding a conservative fund right now!
DISCLAIMER: The opinions expressed in this article are the author’s and shouldn’t be taken as financial advice, or a recommendation of any financial product.