what exactly is capital preservation? (IT question)

12tonelizzie

what exactly is capital preservation? (IT question)

Linton

Capital preservation is the aim of ensuring the value of your investment doesnt go down in cash terms.

Inflation proofing is ensuring that the value of your investment (or possibly the value of your income) increases at least in line with inflation so your real wealth stays constant or increases.

Both imply some sort of guarantee and guarantees cost money to provide. So the value of your investment/income could be less than that you would have received had you not had the guarantee.

Linton

Full capital preservation (and full inflation proofing) can only be absolutely guaranteed (well as near as anything in this life can be guaranteed) with British Government bonds, otherwise known as "gilts". These return fixed rate interest.

But of course you pay for that guarantee with pretty low returns.

Then the more you are prepared to sacrifice full and absolute guarantees the greater your potential return (or potential loss) could be.

So what you would normally do is to have part of your portfolio in Gilts or company bonds (guarantee not so strong) or funds based on these and part in more risky investments. In that way you wont lose everything if the risky investments turn bad, but you will have a reasonable chance of doing far better than with gilts.

The key decision with a portfolio is asset allocation. That is what % of your total investments do you put into safe but low return investments and what % in better return but not so safe ones.

What %s you choose depends on how you personally can handle a drop in values - will you have a nervous breakdown if your investments temporarily drop say 20%? - and your time scale. The shorter your time scale the more likely you go for bonds of some form. WIth a long time scale the riskier investments are more likely to deliver.

Ark_Welder

Capital preservation is an investment style. At its most simple, an individual could bung their assets into index-linked certificates to protect against the ravages of inflation. The downside of this is that when inflation is low, the value of the assets do not increase by much, and there is the chance that other assets might outperform. And this shows a risk of holding IL certificates - their potential to underperform against other assets over the duration.

Fund managers (IT and OEIC) might try to preserve capital by using derivatives to protect against falling prices, by asset allocation and swapping between different types of assets, or both. For this style of investment, performance against benchmarks such as the FTSE All-Share is just about irrelevant (my opinion), because the aim is more about not losing value than it is about beating 'the market' - certainly over short periods.

As an example, the Trojan Fund (closed to new investors, the web-site says) has underperformed the All-Share over the last 12 and 24 month periods on a total-return basis (Trustnet charting tool). But over 36 months it has outperformed:

[edit]
.......... 1Yr 2Yr 3Yr
..........

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All-Share: 22% 59% 25%
Trojan O : 15% 42% 56%

If you look at the 3-year charts, you will see the reason: from July 2008 to March 2009 the All-Share lost around 33%, but the Trojan fund was down about 0.5% (or level, give or take a day). So because the fund preserved its capital over that period it started from a higher base when market sentiment improved.

Looking at the chart from August 2004 there was a 3-year underperfomance against the All-Share, and then an 18-month outperformance. Over the past 7 years, the total return on the All-Share is around 80%, and on Trojan it is 100%.

This shows that it can be more important to not lose money when markets are falling as it to outperform - or match - the market when it is rising. (a reason for looking at some managed funds as well as trackers, perhaps?)

I do have a holding in the Trojan fund and would not expect it to have necessarily outperformed at a time of rising equity markets - that is not its mandate. After all, it does hold about 25% in US inflation-linked treasury bonds and 12% in gold bullion. For me, in this instance with this fund, the performance of 'the market' has no relevance.

Ark_Welder

12tonelizzie wrote: »

Very helpful, thanks. So it seems that the answer to my question "Does [capital preservation] usually imply a goal of capital growth but with less volatility?" is pretty much yes.

Yes!

12tonelizzie wrote: »

Isn't this also what is meant by "Balanced Managed"?

It ought to be... Looking a the 5-year charts (using HL) for the Balanced Managed sector (i.e. the average) against the All-Share on a total return basis, the sector bottomed at -20% and is now up 20%, and the index bottomed at -33% and is up 25%. The problem with all of the 'managed' sectors (Balanced, Cautious and Active) is that some of the funds in them have higher than expected weightings in some asset classes - up to 80% in equities in some cases. Is that necessarily balanced? And in the context of a 30-year bull market in bonds and all-time lows for interest rates, would an 80% holding in bonds necessarily be cautious? There is a lot of debate amongst fund manager associations, intermediaries etc, about renaming these sectors to make them more meaningful (...A, B, C, D at one point!:rotfl:). We'll have to wait and see on that.

The Jupiter Merlin is a fund-of-funds, hence the higher TER - their own fund charge and the underlying funds' charges. But if they are producing outperformance then it suggests that they are able to add value with their selections.

12tonelizzie wrote: »

Is this Troy CF Trojan Fund Class I? Of which Smiley Dampier says "This fund has a focus on sheltering capital"? Or do you mean an equivalent IT?

Yes, it is that OEIC fund. Their web-site does say that it is closed to new investors, but that may be just the 'O' shares which are available to direct investors. The 'I' (for Intermediary) shares look as if they are still available through HL but with a higer annual charge.

The equivalent IT is Personal Assets Trust, because the fund manager and management company are the same: Sebastion Lyon at Troy Asset Management. TAML was awarded management of PATplc in March 2009 due their similar investment style and outlook to the previous manager, who passed away.

12tonelizzie wrote: »

...then a conventional gilt tracker holding will defend against equity dips, and an index-linked gilt tracker holding will contribute defence against inflation. In other words, "capital preservation" or "balanced managed" by means of a balanced portfolio of trackers.

In effect, you are your own balanced management fund! I would not strictly say that holding gilts 'defends' against stock market falls, but the sentiment is correct, i.e. the asset diversification mitigates stock market risk

Two points to consider with gilts and other bonds: there has been a 30-year bull market in bonds which has coincided with a time of interests rates trending lower, so there might be the chance of a reduction in capital from this point forward; Index-Linked gilts (and funds) are subject to investor demand, so when expectations of higher inflation abound, index-linkers will be higher in price than when inflation expectations are low, so if inflation does turn out to be lower than expected and the IL is held to redemption, the return may actually be lower than inflation.

Neither of the above are reasons for not investing in gilts at this time, just something of which to be aware. Actually, this is my dilemma at the moment - should I reduce my slightly overweight bond position, and if so, from which area(s) and where should the proceeds go? But that's another discussion!

12tonelizzie wrote: »

However, as I say, I consider myself an index investor (of 2.5 months vintage).....As I learn more, I'll maybe try managed OEICs and ITs.

It looks like you are navigating toward an investment style known as Core & Satellite: holding index trackers for the core of the investment and then using managed funds to gain exposure to other areas. Some discresionary management firms use this method for their clients, and some firms for their own investments too.

There is nothing wrong with investing in a manner with which you are comfortable. [edit] The wrong way is to invest in something or in some way just because others do so or suggest that you do so, but without saying why they do so - it may be right for them, but it does not automatically mean that it is right for you . Think of starting off in investing as being similar to driving in fog: there are those who choose to go as fast as they can, closely following all that is (put) before them without any ability to see further than that, whereas others prefer to take things more slowly, keep a bit of distance, and give themselves time to act accordingly.