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Why are conservative fund returns worse than growth funds?


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In a bear market, conservative funds performance can be worse than growth funds. And that’s been the case with our Conservative Funds too.

But why?

For the investment experts who understand the mathematics of bond returns, it's perfectly logical. When interest rates rise sharply, the long dated nature of our bond portfolio means we enter a period of relative under performance vs shorter dated bonds. But history and logic says they should out perform over the long term, which our conservative funds have to date.

But for many investors, conservative funds doing worse in tough times can seem strange. That's because many people invest in them, never expecting them to go down.

The good news is that if you stay invested, you shouldn’t lose any money, and will actually make money. Here’s why.

When a conservative fund goes down, some of it will be because the sharemarkets go down. Approximately 20% of our Conservative funds are invested in shares, so that is part of the reason.

However, most of the short term underperformance is because conservative funds hold lots of investment grade bonds, usually issued by the Government or local authorities. 

And if our funds hold government bonds paying (say) 1% in interest, they are less valuable than any newly issued bonds paying (say) 3% interest. 

But any ‘loss’ from holding lower interest bonds is theoretical only.  If the bond is held to maturity it gets fully repaid, with the 1% interest too. There is only a loss of money if the bond is sold at its current value, before it matures.

So if you stay invested, the conservative fund returns should rise over time.

Over the long term, investors should expect something like a 3.5% return from a conservative fund over time, adjusted for inflation.

About one in every 7 years, long term bonds underperform. And it’s this times like these that otherwise high fee, under-performing fund managers crow about beating the market.

But history, and a huge swathe of academic studies, show that picking the direction of share and bond markets is a fools game. The tragedy is that this guessing game is paid for by their customers.

By staying invested long term, in funds with investment grade bonds (as ours are), investors are rewarded over time, and protect their capital.