The way the markets have started 2018 suggests that we have entered a new phase of heightened volatility with plenty of downside risk. Investors who are uncomfortable with this environment may want to protect their capital by increasing their exposure to some of the more defensively positioned funds. These use a variety of strategies to reduce market risk.
One such is the £400 million Ruffer Investment Company (LON:RICA) that aims to achieve a positive total annual return, after all expenses, of at least twice the Bank of England Bank Rate by investing in a range of UK and overseas shares and bonds. Since it was launched in July 2004 it has generated a cumulative NAV total return of 186%, which is slightly less than the FTSE All-Share Total Return Index but with much lower volatility and a lower maximum drawdown (worst peak to trough decline) of -8.61%.
RICA’s managers are positive about the health of the global economy, yet they are nervous about the elevated market valuations and technical fragilities such as the inverse volatility trade, whose reversal prompted the sharp drop in the Dow Jones Index at the start of February. In order to guard against this they have invested 55% of the portfolio in a mixture of index-linked government bonds, cash, gold, options and protective illiquid strategies.
Another good defensively orientated option is the £4.5 billion Troy Trojan fund, managed by Sebastian Lyon. Over the period since it was launched in May 2001 it has achieved the rare feat of outperforming the FTSE All-Share Total Return Index by 72% with about half of the annualised volatility and a maximum drawdown of -13.7% compared to -45.6% for the index.
Lyon is concerned about the pickup in global inflationary pressures that could result in higher interest rates and higher bond yields and the impact that this might have on the elevated valuations of the stock market. To protect against this he has increased his cash weighting to a massive 30% with a further 5.4% in gold bullion securities, with the rest of the fund invested in high quality blue chip stocks with steady earnings.
He also manages the £860 million Personal Assets Trust (LON:PNL) along similar lines, and at the end of November – the latest date for which the data is available – he had allocated a total of 57.6% to a combination of index-linked bonds, UK Treasury Bills, cash and gold bullion.
The award for the most prescient update goes to David Crawford, the manager of the £248 million City Financial Absolute Equity fund, who in his December factsheet said: “It looks increasingly possible that a change in market direction will come more suddenly (‘a crash’). We believe this is a plausible scenario, as low volatility brings more and more participants into the market and encourages the use of leverage. A small change in sentiment could cause selling, which could then be exacerbated due to current market structure.”
Crawford aims to achieve positive absolute returns over rolling 36-month periods through a fundamental long/short strategy. Unlike most of his peer group he is not afraid to back his convictions and over the period since launch in March 2008 his fund has achieved an impressive annualised return of 14.7%, which is well ahead of the FTSE All-Share Total Return Index, albeit with a higher level of volatility.
His bearish outlook meant that he started 2018 right on the limit of his negative positioning, with a net short position of -2.3% (excluding the Aldermore Group that is in the latter stages of being acquired). This made it one of the best performing funds during the market sell-off, although it has since given back these gains as prices have recovered.