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