Global markets have been on a rollercoaster ride over recent weeks, spooked by the announcement of fresh tariffs on Chinese goods by US President Donald Trump and the inversion of the yield curve in bond markets, a common harbinger of a recession.
The CBOE Volatility index - or Vix - is a common measure of stock market volatility. It has surged around 20% since the beginning of August, with volatility hitting markets across the globe.
At times like these, certain funds can offer defensive characteristics to help protect investors’ capital. Two such vehicles favoured by fund selectors for holding high levels of cash during times of market stress are the £4.3bn Gold-rated Troy Trojan fund managed by Sebastian Lyon and Ben Leyland’s £435m JOHCM Global Opportunities. Both have delivered strong long-term returns: Lyon’s vehicle is up 7% over 10 years on an annualised basis, while Leyland has delivered an annualised return of 13% over five years.
Darius McDermott, managing director at Chelsea Financial Services, also likes Dan Roberts’ £1.4bn Fidelity Global Dividend, rated Bronze by Morningstar, as a place for investors to hide out when markets get choppy. The fund has focused on generating outperformance in difficult conditions, while keeping up in strongly rising markets.
Absolute Return
However, if equity markets suffer further hits, it may be time to look at alternative exposures to improve portfolio diversification. Absolute return funds could come into their own during this time - although investors have been piling out of these funds after a run of disappointing performance.
One such fund could be James Clunie’s £1.3bn Jupiter Absolute Return. Over the past three years it has struggled to produce a positive return (see table) and has seen its rating lowered from Bronze to Neutral by Morningstar analysts as a result. The underperformance can be explained by its value tilt and bias towards the UK, while shorting US growth stocks.
However, some analysts believe the vehicle could shine in downward trending markets due to its defensive positioning, including its sizeable position in gold.
Scott Spencer of BMO GAM’s multi-manager team suggests investors look at Merian UK Specialist Equity as a long/short option - meaning the manager has the option to short, or bet against stocks, as well as invest in those it believes will rise. The £492 million fund, run by Tim Service, has returned 6.6% over the past three years on an annualised basis.
Another pick for Spencer is an absolute-return minded fixed income product: $6.7 billion Legg Mason Western Asset Macro Opportunities, which is led by Western Asset chief investment officer Kenneth Leech and carries a Bonze rating.
Morningstar’s senior analyst Ashis Dash thinks it is one of the more flexible funds in its category, with a wide duration range of negative five to 10 years and boasting liberal use of derivatives. “The fund's relatively high 10% annual standard deviation limit also gives it the ability to ride out interim volatility,” he says. “The managers have made good use of this flexibility since inception in November 2013.”
However, Dash warns that the fund’s high-conviction nature could lead to large performance swings, seen in early 2016 and again in July 2018.
Consider Alternatives
Experts also suggest looking at other alternative exposure, such as infrastructure funds, for portfolio diversification and as a way to pick up extra yield when equity returns peter out.
Ben Yearsley, director at Shore Financial Planning, likes the £36 million Time Defensive Income Securities fund, which invests in infrastructure investment trusts. Launched last April, it has returned 8.2% year-to-date.
Yearsley says: “The benefit of many of these types of infrastructure projects is that the underlying income streams are not dependent on the health of the economy or what’s going on in China, and they often have some form of inflation linkage too.”
In the same vein, he recommends the £260 million two-star rated Architas Diversified Real Assets. The fund targets a return of cash +4%-5% every year by investing in an “esoteric bucket of investments”, from specialist insurance to renewable energy to aircraft leasing. “Sounds random, but the thing they all have in common is reliable dependable cash flow.”
Meanwhile, Chelsea’s McDermott backs the £462 million VT Gravis UK Infrastructure Income fund, also two-star rated, saying: “Last time I looked, it was yielding north of 5%. If you’re fearful of markets and looking for defensive returns, I would expect it to outperform.”
He also recommends Nick Martin’s £1.5 billion Polar Capital Global Insurance fund for its lower correlation to equity markets and the sector’s ability to outperform when markets go down. This fund, which has a Silver Morningstar rating, is an opportunity to gain alternative exposure to the US at a time when its flagship indices are suffering, he added.
Morningstar analyst Samuel Meakin says “has generally delivered a more stable performance profile than its benchmark and the broader financials peer group by helping to protect capital better in falling markets”. For example, it delivered a small positive return in 2011 when the index was down 11%, he adds.
