YOUR BEST IN­TER­ESTS

With in­ter­est rates at zero per cent, Robert Kent con­sid­ers whether in­vest­ing in ‘ fonds en euro’ is a good op­tion

Living France - - Contents - Robert Kent is man­ag­ing di­rec­tor at tax and in­vest­ment con­sul­tants Kent­ing­tons kent­ing­tons.com

Robert Kent ex­plains whether in­vest­ing in ‘ fonds en euro’ is still a good op­tion

Have you no­ticed that the word ‘in­ter­est’, when ap­plied to earn­ings on sav­ings, has be­come some­what of an oxy­moron? The Euro­pean Cen­tral Bank rate is cur­rently ex­actly 0%. Oddly, this is com­pletely in line with the in­fla­tion rate in France in 2015 (also 0%). If you pri­ori­tise safety over re­turn, then you can in­vest in Ger­man govern­ment bonds, but even the 10-year ver­sion will not be ex­cit­ing (not for the in­vestor any­way), as it cur­rently pays a neg­a­tive yield.

The prob­lem is that peo­ple, com­pa­nies, pen­sion funds and fund man­agers are all chas­ing a rea­son­able re­turn, tak­ing risks that they would not nor­mally take, set­ting the stage for a roller coaster stock market.

In this dif­fi­cult eco­nomic cli­mate, how can some­one get their cash to cre­ate an in­come and/or growth with­out the volatil­ity and huge un­cer­tainty of stock market in­vest­ment?

FONDS EN EU­ROS

In France, a well known so­lu­tion of get­ting a ‘risk-free’ re­turn is by us­ing a fonds en eu­ros, al­though it’s worth not­ing that com­pletely risk-free is not pos­si­ble.

These kinds of funds have ex­isted in France for many years, so orig­i­nally they were fonds en francs. It’s a very generic and odd name, since log­i­cally any funds de­nom­i­nated in eu­ros are funds in eu­ros. They are not; these funds are quite unique, in that there is a guar­an­tee, not only that your cap­i­tal is safe, se­cure and will not re­duce in value, but that it must in­crease, by a cer­tain per­cent­age, ev­ery year. Though it has never hap­pened in its long his­tory, that per­cent­age could tech­ni­cally be zero.

Cur­rently, they are pay­ing around 2.50% net, though providers, es­pe­cially banks, may try to mis­lead you by telling you the re­turn be­fore all the charges. A to­tal of 2.50% may not sound very ex­cit­ing but there is no doubt that it is prefer­able to zero or the neg­a­tive re­turn of Ger­man 10-year bonds. There is ab­so­lutely no lock-in or abil­ity to revalue in times of cri­sis, which means that this fund may ar­guably be used as a cash po­si­tion.

The prob­lem is that there is a lot of press neg­a­tiv­ity about this kind of fund at the mo­ment. If it’s so great, then what is the fuss about?

HOW DOES IT WORK?

A rate of 2.50% seems too good to be true, so how does it ac­tu­ally work? It is very dif­fi­cult to ob­tain a de­cent ex­pla­na­tion on how fonds en eu­ros work, beyond that ‘it is in some kind of bond port­fo­lio’.

This is, in fact, cor­rect, but it is how it is man­aged that sets it apart. A typ­i­cal bond fund will buy and sell as­sets daily, mak­ing gains and re­al­is­ing losses, de­pend­ing on how com­pe­tent (and for­tu­itous) the man­ager hap­pens to be. The bonds will pay in­ter­est or what is called a coupon, but these may be wiped out at any mo­ment by a sig­nif­i­cant re­duc­tion in the bonds’ value.

The fonds en eu­ros is dif­fer­ent. It gen­er­ally buys long-term qual­ity bonds and never sells. Mak­ing gains on bond sales is not the goal, so they are held un­til ma­tu­rity. A UK govern­ment bond, for ex­am­ple, is called a ‘gilt’. They are is­sued at £100 and they are re­deemed at £100. Dur­ing its life it pays a coupon/the in­ter­est, which is fixed. The main risk is that they are not re­deemed, since there is no change in value. The rea­son that the re­turns are greater than de­posit is that some of the bonds within these funds are 10-15 years old, so come from a pe­riod of high in­ter­est rates which im­pact the per­for­mance of the bond market (I will cover this shortly).

It gets bet­ter, as the com­pany is­su­ing this kind of fund has to back the fund, giv­ing a guar­an­tee. Nat­u­rally, this guar­an­tee is only as good as the com­pany or in­deed the sup­port­ing struc­ture be­hind it. As with bank ac­counts, some are go­ing to be more sta­ble and se­cure than oth­ers. Those based in cer­tain ju­ris­dic­tions are forced, by law, to place their own as­sets in es­crow, sup­port­ing the fund euro for euro (or in­deed pound for pound as a ster­ling vari­ant does ex­ist).

PO­TEN­TIAL PROB­LEMS

Hav­ing cov­ered how it works, why are there prob­lems com­ing their way? As pre­vi­ously ex­plained, the in­ter­est or coupon paid by a bond is­sue is affected by in­ter­est rates, or to be more pre­cise, Cen­tral Bank rates. There is not a di­rect link, it is merely to make a bond is­sue at­trac­tive, and to do this it clearly has to pay more than can be achieved on de­posit. The prob­lem is that in­ter­est rates have been low for a record length of time. Zero per cent is re­ally not dif­fi­cult to beat!

These funds con­tain bonds that are ma­tur­ing, but what are they be­ing re­placed with? New bonds at new rates which are very poor. What do man­agers do now? Buy long-term to get the best rate or buy short ac­cept­ing a poor re­turn, hop­ing for bet­ter rates soon? This means re­turns have been grad­u­ally re­duc­ing for a few years now and the down­ward trend is set to con­tinue.

It is a math­e­mat­i­cal cer­tainty that these funds will give up the ghost at some point, as in­ter­est rates have sim­ply been too low for too long. It does not mean that they will be neg­a­tive, but pay­ing noth­ing, as ex­plained ear­lier, is tech­ni­cally pos­si­ble. There will be charges on the fund, so clearly the net re­turn could in­deed be­come neg­a­tive.

In France, a well known so­lu­tion of get­ting a ‘risk-free’ re­turn is by us­ing a fonds en eu­ros

CAUSE FOR CON­CERN?

There is ab­so­lutely no need to worry at all, for the mo­ment at least. Re­turns are still very good com­pared to other op­tions. We are still rec­om­mend­ing this fund to our clients. It is still the very best way to get a pos­i­tive re­turn with a risk pro­file equal to cash in a bank. The point is that as soon as we feel that there is a bet­ter so­lu­tion, we can im­me­di­ately change be­cause the money may be moved quickly if needed. No lock-in, or ad­just­ment pos­si­bil­ity means no worry.

A cash po­si­tion with a rea­son­able re­turn is needed, even for those com­fort­able with market volatil­ity, even if just to go to the side­lines to wait for an op­por­tu­nity.

Many peo­ple are sim­ply risk-averse and look­ing for the best re­turn on their money, ac­cept­ing that re­turns will not be high.

Be­ware, many ad­vis­ers are try­ing to push their clients into stock market funds to get ‘bet­ter re­turns’, even those who have stated that they are ner­vous about the mar­kets and are not suited to that kind of in­vest­ment. There are two rea­sons for this; one be­ing that stock market-based funds, known as unités de compte, sim­ply pay more to the fi­nan­cial in­sti­tu­tion or the ad­viser. The sec­ond is that many for­eign ad­vis­ers sim­ply do not have ac­cess to this kind of fund, due to their lack of lo­cal reg­u­la­tion, so will sim­ply rub­bish it, as they are un­able to of­fer it.

Even if these funds be­come com­pletely re­dun­dant (pay­ing lit­tle or noth­ing) for a few years while in­ter­est rates re­cover, they will have their mo­ment of glory again, so hav­ing ac­cess to them is de­sir­able, even if they are not use­ful in the short-term.

We will mon­i­tor the re­turns of this kind of fund and will con­tinue to rec­om­mend them for as long as they out­per­form all else.

If you are be­ing en­cour­aged to exit this kind of fund, or worse, leave your cur­rent in­vest­ment com­pany for one that can­not of­fer this kind of fund, you might want to ask more ques­tions about the mo­tives.

No one should feel forced into a sit­u­a­tion with their money where they are anx­ious and wor­ried. I am pos­i­tive about the market longterm, but I ex­pect market volatil­ity on a huge scale for some time to come and this is not ac­cept­able to all.

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