The security of holding cash in the bank for a special occasion or a rainy day is impossible to match, but if you’re looking to diversify your equity risk with something capable of a real return, there are some possible options.
Here are three rated by the experts.
Absolute Return funds
IMA Targeted Absolute Return has been one of the more controversial sectors in recent years, with experts hitting out at funds that have unsuccessfully protected investors’ money in down periods.
However, head of research at Whitechurch Ben Willis says there are a handful of funds that have effectively stripped out market risk, providing investors a positive return year after year. “The best way to measure an absolute return fund is looking at how they’ve coped during the tough times – namely 2008 and 2011, and even the beginning of this year,” he explained.
“You want to find which ones hold up, even if the markets are falling all around them.”
“In this regard one clearly stands out for me. It’s had a great start to the year, in that it’s been completely unaffected by the market turbulence. It’s as dull as any fund you can find, which is exactly what we want – BlackRock European Absolute Alpha.”
Performance of fund, sector and indices in 2014
Source: FE Analytics
Vincent Devlin’s £68m BlackRock portfolio has managed positive returns of 2.7 per cent so far this year, compared to losses of 1.89 per cent from the FTSE All Share. It has successfully delivered a positive return every year since its launch in 2009.
Devlin uses a market neutral strategy called “pair trading”, which involves going long and short on two stocks from the same investment sector. This enables the manager to minimise equity risk.
Willis also rates the Insight Absolute Insight Equity Market Neutral fund in this area. David Headland and his team have managed a positive return every year since 2007.
Over a three year period the Insight fund has operated with even less volatility than the BlackRock fund, as the graph below illustrates.
Risk/return of funds and FTSE All Share over 3yrs
Source: FE Analytics
Insight Absolute Insight Equity Market Neutral has a max drawdown of just 0.86 per cent over three years, compared to 1.64 per cent from BlackRock European Absolute Alpha. The BlackRock fund has returned more, though.
Inflation-linked bond funds
An inflation-linked bond fund is a good way to hedge against a possible rise in inflation, but they are susceptible to downside pressures if CPI expectations fall.
Ben Lord’s £857m M&G UK Inflation-Linked Corporate Bond have been particularly successful in mitigating credit risk with inflation-protection, which has helped it beat cash and inflation since its launch in September 2010.
Performance of fund, sector and indices since launch
Source: FE Analytics
The fund has been one of the least volatile in the IMA Strategic Bond sector, with a max drawdown – which measures how much you would have lost if you’d bought and sold at the worst possible moment – of 3.71 per cent. This compares to 4.19 per cent from its sector, and 11.41 per cent from the FTSE All Share.
The fund invests in both inflation-linked corporate and government bonds. By combining short-dated index-linked gilts with derivatives based on the creditworthiness of companies they produce “synthetic” index-linked bonds, which have little downside risk.
Willis points out Lord and co-manager Jim Leaviss are currently overweight short-duration which will help to protect against a rise in interest rates, adding that the vast majority of the fund’s bonds are high in quality.
Ground rents funds
Neil Shillito, managing director of SG Wealth Management, uses Nigel Ashfield’s Freehold Authorised Income Trust as a low-risk diversifier.
Ashfield attempts to provide a secure and stable return primarily through acquiring freehold ground rents which offer both an income stream and capital growth prospects. It has a target yield of 4.25 per cent.
The predictable flow of capital has enabled the fund to deliver an unbroken track record of positive returns for 20 consecutive years. It has consistently outperformed cash, gilts and inflation in the process.
Performance of fund and indices over 20yrs
Source: FE Analytics
The fund’s volatility score is minimal, and incredibly it has a max drawdown of 0 per cent over the past decade.
Investors cannot get access to the fund without a financial adviser. Though Willis likes the concept, he says such products have poor liquidity.
“The question mark always comes when you want to take your money out, as investors in the Brandeaux funds have found recently,” he said.
Unlike the Brandeaux funds which are in the process of being wound-up, the Freehold fund is regulated as a PAIF [property authorised investment fund].