Riskier Than You Might Think

Sydney Morning Herald

Wednesday April 9, 2008

By Lesley Parker

That 'safe' cash investment fund may be deceiving.

Cash has always been regarded as a haven in troubled times but concern is growing about the disguised risk in some supposedly "safe" cash-based investment funds.

Investors are being urged to make sure they know exactly what they're investing in when it comes to new-style "enhanced cash" products.

Such funds are sold as a way to achieve above-average cash returns - perhaps 50 basis points or even a full percentage point above prevailing yields.

"They do that by investing in cash but with a 'kicker' in there," says Phillip Gray, a spokesman for fund researcher Morningstar. That kicker may be, for example, some reasonably high-quality corporate bonds.

"So the risk profile is a little higher than with cash, because you're starting to get a credit-quality exposure."

Credit risk is the possibility that a company might default on its debt. It's not a risk you used to find with the plain-vanilla cash products that were the norm just a few years ago.

Today there are 47 cash-enhanced trusts on Morningstar's database, with total assets of $11.2 billion. That compares with 70 ordinary cash trusts with total assets of $53.5 billion. In other words, cash-enhanced trusts make up 40 per cent of all cash trusts and account for 17 per cent of total assets.

The sorts of risks potentially involved in cash-enhanced funds were highlighted in Australia last month, when fund manager Perpetual revealed that net losses from its Exact Market Cash Fund now stood at $19.4 million.

The fund had invested in complex collateralised debt obligations linked to US subprime mortgages, along with Australian residential mortgage-backed securities.

Perpetual said $3.5 million of the losses from the fund were subprime-related and not likely to be recovered.

Fortunately for investors in the fund, Perpetual had offered a guaranteed return of 6.5 per cent and so is obliged to make up the difference between that rate and the return it is actually achieving - said at the time to be about 5.75 per cent.

The losses disclosed by Perpetual, a listed company, will instead go to its bottom line, making them an issue for investors in the company itself.

Troubled funds management group MFS has just announced its intention to wind up its cash-enhanced fund (which shows up with the top return on our table), saying that "lack of critical mass in funds invested and the withdrawal of major investments" means the fund is unlikely to be sustainable.

In the US - the home of the credit crisis - some "ultra-short" bond funds that were marketed as an alternative to cash are in even more trouble.

Charles Schwab's YieldPlus fund - which was advertised on its website as "a smart alternative for your cash", involving "only marginally higher risk than money market funds" - has lost 13 per cent of its value so far this year.

Investors who got into it thinking it was virtually as good as cash have begun class-action lawsuits.

Similar funds run by State Street Global Advisers and Fidelity are down 11.8 and 5.1 per cent respectively. State Street is also the subject of lawsuits as a result and is looking for a new chief executive.

Gray says the lesson from such examples is that people need to know exactly what they're getting into.

"Just think carefully about the yield you're being offered - where's that yield coming from?" he says.

No investment is 100 per cent safe "but it's worth trying to get your head around what the risks are, being informed and incorporating that into your decision making".

If a fund label incorporates words such as "enhanced" or "plus", take an even closer look, Gray says. "It may be a warning that this is not a fund wholly invested in short-term cash, that it's got something else in there. Try to decode the language that's used."

Doug Webber, an associate director with Macquarie Private Wealth, agrees. "With anything, if you're going to get a better return through an 'enhanced' product, then you do need to understand where that enhancement is coming from. It can come from a number of different areas - it's pretty important to understand that."

With regard to perceptions of safety, Webber says that in the 1990s people invested in government bonds, seeing them as extremely safe.

"Then interest rates took off and these things just tanked in capital value," he says. People where left shaking their heads and asking "why?"

Finally, don't underestimate the impact of fees when considering cash investments, Gray says.

"It's especially important to know exactly what you're paying when investing in cash and what effect this has," he says. "Because cash is a relatively low-yielding asset class, and because most cash funds are pretty much the same these days, the critical issue for investors to focus on is the amount they're paying in fees.

"If you're getting 7 per cent gross from a cash fund and inflation is 3 per cent, your effective 'real' return before fees is only 4 per cent. If you're paying another 1.5 per cent in fees, then your effective real, after-fee return is only 2.5 per cent."

© 2008 Sydney Morning Herald

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