Our Service Proposition : Understanding the risks
Helping you understand the risk of different assets
To help understand how an investment might behave TFM broadly classify them on a scale of 1 to 6, 1 being very low risk, 6 being very high risk. It is important to understand that there is a close relationship between risk and reward. Without accepting the risk of loss, it is not realistic to anticipate significant larger than inflation returns.
Profile 1 E.G. Deposit Accounts
Cash/Deposit - Your money is safe, i.e. its value won’t go down. However, there is less growth potential than other investments as inflation may erode your returns and reduce your purchasing power.
Deposit accounts may not carry of the risks to capital involved in bonds or shares but this does not mean they are risk-free. There is always the danger that inflation will eat into the value of your savings. Your real return – the amount of interest you earn above inflation – can be a very small margin. If your account pays 5% but inflation is running at 2%, you are only making 3% in real terms. A small rise in inflation or a slight drop in interest rates could make a significant dent in your returns. If your savings are taxed, that real return of 3% will be reduced even further, (although this is not the case with ISA (Individual Savings Account) investments as they are income tax free). As such, a Deposit Account does not represent a long term investment, rather a place for holding liquid capital.
Risk to capital: limited to default by the institution in the short term, and vulnerable to inflation in the long term.
Profile 2 E.G. Cash Funds, Gilt and Fixed Interest Funds
Collective investment investing in “cash” may also invest in money market securities, and as such do carry a marginally higher risk factor than ordinary cash deposit accounts. In addition to this, there will be management charges or product charges that must be offset first before a return is generated.
Gilt and Fixed Interest Securities, otherwise known as Bonds, represent loans to Governments and Companies. They carry less risk than shares, but more growth potential than savings accounts.
Bonds also pay regular income, which can be reinvested for long-term growth. However, they are not as secure as a savings account, and bond funds can go down in value. The capital value will be affected by changes in interest rates, and the lender bears the risk of capital loss where the borrower defaults. Corporate Bonds are a form of Fixed Interest Security, but have greater risk than Gilts.
HIGH YEILD CORPORATE BOND FUNDS CARRY THE SAME RISKS TO CAPITAL AS EQUITY FUNDS
Risk to capital: present, but in lower ratio than with shares, susceptible to capital fluctuation in times of changing interest rates.
Profile 3 E.G. Cautious Managed Funds, Commercial Property Funds
Cautious Managed/Distribution Funds contain a combination of assets, and will hold cash, shares and bonds. As well as different assets, the funds will invest in different markets with the objective of spreading risk, and reducing the potential downside when compared to pure equity funds. Cautious Managed and Distribution funds are limited to 60% as a maximum in equities.
Risk to capital: greater than Bonds due to equity content, but less than pure equity funds.
Commercial Property Funds invest in “bricks and mortar” real estate and generate an income stream through rents, and aim to achieve additional wealth creation through capital growth. Historically commercial property funds have not been correlated with equity funds. These assets carry less downside risk than equities, but may suffer from sharp correction, and fund managers are able to declare moratorium on withdrawals from this type of fund in adverse market conditions.
Risk to capital: greater than Bonds due to illiquidity.
Profile 4 E.G. Balanced Managed Funds
Balanced Managed Funds contain a combination of assets, and will hold cash, shares and bonds. As well as different assets, the funds will invest in different markets with the objective of spreading risk, and reducing the potential downside when compare to pure equity funds.
Balanced Managed Funds can contain 80% as a maximum in stocks and shares.
Risk to capital: greater than Cautious Managed Funds due to additional equity exposure.
Profile 4 Example – Balanced Managed Funds
Profile 5 E.G. Pure focused equity funds in the UK and abroad
Shares, (Equities) - Good long-term growth potential. Equity funds allow you to invest in thousands of company shares and a broad range of markets and offer flexible ways to invest and withdraw money. However, because shares fluctuate in value, they involve more risk than bonds and deposit accounts.
Risk to capital: offers a significant risk in the short term, which reduces the longer that the investment is held. Pure equity funds require a five year window as a minimum in order to alleviate short term volatility.
Profile 6 E.G. highly specialist equity funds/commodities funds
Shares, (Equities) - Good long-term growth potential, but a limited focus, or “thematic investing” can increase the overall risk, as can investing in less mature markets. Profile 6 funds offer high potential rewards long term, but there is a genuine risk to capital.
Commodities themselves are also traded in this bracket. Commodities carry a greater risk than a collective equity fund, as the risk is concentrated in one asset, and not spread amongst many securities.
Risk to capital: offers significant risk: this reduces the longer the investment is held, but these investments are more volatile than mainstream focused equity funds, and capital is absolutely at risk.