Three Investment Trusts with Downside Protection

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Three Investment Trusts with Downside Protection

Concerns are growing about a possible stock market correction when central banks start to taper their bond buying programmes, but there are a handful of investment trusts that can protect you against a crash.

Most equity funds expose you to full market risk which is an uncomfortable place to be when valuations are stretched and central banks start tightening monetary policy. It is perfectly possible that we could see a sizeable correction if the liquidity is withdrawn too quickly or inflation becoming a persistent problem if it tapers off too slowly.

One way that you can remain invested without risking your shirt is the Diverse Income Trust (LON: DIVI) which holds UK dividend-paying stocks with a range different market capitalisations including some listed on AIM. It has recently reinstated its ‘put option’ insurance policy that provides some protection against a market crash.

Writing in the latest annual accounts, the managers said that they were concerned about the impact of rising interest rates and the unsustainable nature of the rapid global economic recovery after the pandemic-induced recession in the short to medium run.

Limiting the downside

Because of this, in recent week a FTSE 100 put with an exercise level of 6,200 and a term to December 2022 covering 38% of the current portfolio value has been purchased.’ This would make a sizeable profit if the index suffered a major slide and could be sold to provide the cash to make additional investments at distressed prices.

The managers have used this approach for years and sold the previous put option at the height of the market crash last March. It is an unusual strategy, but it helped the investment trust to achieve its best ever financial year with an NAV total return of 38.4% in the 12 months to the end of May 2021.

Another investment trust that can benefit from similar protection is the listed hedge fund Pershing Square Holdings (LON: PSH). It takes large stakes in a concentrated portfolio of US-listed stocks, but has the scope to use derivatives to profit from market dislocations.

Profiting from a crash

Billionaire founder Bill Ackman foresaw the coronavirus-induced crash last year and made a huge profit from a short position in credit default swaps that was then re-invested in the market. His main concern in 2021 is the impact of sharply rising bond yields and in order to guard against this he has bought large notional hedges in the form of interest rate swaptions on 10-year US Treasury bonds.

A fund like PSH will actively manage these sorts of exposures and can change them at the drop of a hat so you are effectively backing the manager’s judgement, but it has had a couple of really strong years and the shares are still available at a 26% discount to NAV.

You get a much more defensive and predictable exposure from the Ruffer Investment Trust (LON: RICA) that offers investors an all-weather, multi-asset portfolio. Illiquid strategies and options play an important role in this and provided solid downside protection during last year’s crash with the managers recently topping up their protection against a spike in bond yields.


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