Toppy valuations in developed equity markets, an economic slowdown in the emerging markets and the still huge amounts of debt in the system are all reasons some investors are wary of taking on huge amounts of risk within their portfolios.
With that in mind, we ask the experts which funds cautious investors should be buying if they want their hard earned cash to be well-protected.
Blackrock European Absolute Alpha
Ben Willis, head of research at Whitechurch, says that if investors want a very cautious portfolio, they should turn to the IMA Targeted Absolute Return sector. He favours the £68m Blackrock European Absolute Alpha, which is managed by Vincent Devlin.
“If you want something that has very low volatility and looks a bit boring, then I would go for Blackrock European Absolute Alpha,” Willis said.
“It is a market neutral fund and the manager effectively trades out all of the beta and has a number of tactical long/short positions in order to grind out a steady, but consistent return. During periods where markets have sold off, it has basically moved sideways.”
“In a strong rally it will be left behind, but it is an ultra-cautious portfolio that should defend your capital.”
According to FE Analytics, the Blackrock European Absolute Return fund has made a positive return in each discrete calendar year since its launch in 2009. In 2011, it returned 5 per cent while the average fund in the IMA Europe ex UK sector fell by 15 per cent, for example.
Performance of fund vs sector in 2011
Source: FE Analytics
The fund has also been top quartile for maximum drawdown – which measures what an investor’s return would be if they bought at the top of the market and sold and the bottom – since its launch.
Blackrock European Absolute Alpha has an ongoing charges figure (OCF) of 1.72 per cent.
Newton Real Return
Willis says that if investors want the chance of higher returns than the Blackrock fund, but still want a cautious portfolio, then they could turn to FE Alpha Manager Iain Stewart’s £9bn Newton Real Return fund.
“It is a multi-asset portfolio so if asset classes are correlated, then it can be quite volatile,” Willis said.
“However, the manager does uses hedging strategies within the fund to manage risk and he tries to deliver a return if LIBOR plus 4 per cent over the long term, which he has tended to do in the past.”
Stewart took over the fund in March 2004, over which time it has returned more than 120 per cent with an annualised volatility of 8 per cent.
The fund has also delivered a positive return in nine out of the last 10 years, the exception being in the falling market of 2011 where Newton Real Return lost 0.75 per cent.
As Willis highlighted, it is higher risk than others in IMA Targeted Absolute Return sector as Stewart holds close to 60 per cent in equities. The rest of the portfolio is split between bonds, cash and commodities. Stewart also uses index options and derivates within the fund to try and mitigate equity market risk.
Its clean share class has an OCF of 1.11 per cent.
M&G Short Dated Corporate Bond
Bonds have traditionally been a cautious investor’s go-to asset class.
However, with yields on most fixed income securities at a very low level compared to their historic averages and as interest rates are expected to rise at some stage over the coming years, James Hutson – managing director at Arjent Limited – says investors should turn to the M&G Short Dated Corporate Bond fund.
“In terms of our managed liquidity allocations, we favour, among others, the M&G Short Dated Corporate Bond,” Hutson said.
“The fund aims to provide a steady flow of income whilst protecting capital by investing in low-risk debt instruments such as floating rate notes and short-dated corporate bonds.”
The £429m M&G Short Dated Corporate Bond fund is managed by Matthew Russell.
Last year was a particularly bad one for bond-holders as yields spiked due concerns surrounding the future of US monetary policy. However, due to the fund’s approach, it has protected capital far better than fund in the IMA Sterling Corporate Bond sector over the last 12 months.
Performance of fund vs sector over 1yr
Source: FE Analytics
As the fund invests in short-dated bonds – and has duration of 1.5 years – it means the portfolio has a very low-sensitivity to interest rate movements because the majority of the fund’s holdings will mature over the next two years.
Russell currently holds 61.6 per cent in traditional bonds, 36.7 per cent in floating rate notes and 1.7 per cent in cash. M&G Short Dated Corporate Bond has a yield of 2.32 per cent and its clean share class has an OCF of 0.66 per cent.
L&G Dynamic Bond
Strategic bond funds have become very popular with investors as they have the flexibility to buy all areas of the fixed income market.
Darius McDermott, managing director at Chelsea Financial, likes using those sorts of portfolios and says that FE Alpha Manager Richard Hodges’ £1.9bn L&G Dynamic Bond fund is one of the best out there.
“If you are looking for strategic bond fund that can defend capital, then I would for the L&G Dynamic Bond fund. Almost everything Richard Hodges does, or something he has a big focus on, is capital protection,” McDermott said.
“He manages the fund with a total return, or even absolute return, mind-set. It is a strategic bond fund and he uses all the flexibility available to him. He also has very good knowledge and expertise of hedging instruments, whether they are futures or CDSs.”
Hodges has managed the fund since it was launched in April 2007. According to FE Analytics his fund has been the second best performing portfolio in the IMA Sterling Strategic Bond sector over that time with returns of 77.3 per cent.
Hodges recently told FE Trustnet that duration is major theme within his portfolio as he says he wants to build in defence against a possible interest rate rise now to be ahead of the curve.
In order to protect his investors from the threat of a possible rate hike, Hodges is keeping duration extremely short and is also building in defence via interest rate swaps.
A large part of his portfolio will mature over the next three years and Hodges says that means he can reinvest that money into higher yielding bonds.
The fund yields 4.8 per cent and its clean share class has an OCF of 0.63 per cent.
Threadneedle UK Equity Income
Equities have historically been a far more volatile asset class than bonds. While they have generated a higher return in the past, they have tended to fall a lot further when market conditions deteriorate.
McDermott says cautious investors should be very careful if they were to hold an equity fund as even the most defensive managers will not to lose money if the market falls. However, if investors do want to take a little bit more risk, he recommends Richard Colwell and FE Alpha Manager Leigh Harrison’s Threadneedle UK Equity Income fund.
“If you are going down the equity route cautious investor, you should probably be looking at an income fund. Say a fund is paying a dividend of 4 per cent, but the market falls 10 per cent, you know you should at least still have that 4 per cent,” McDermott said.
“We like the Threadneedle UK Equity Income fund. It primarily invests in large caps which tend to be more defensive,” he added.
The five crown rated fund, which has an AUM of £2.6bn, was launched in May 2009.
Our data shows that over that time Threadneedle UK Equity Income has been a top quartile performer in the IMA UK Equity Income sector with returns of 105.58 per cent, beating its benchmark – the FTSE All Share – by more than 20 percentage points.
Performance of fund vs sector and index since May 2009
Source: FE Analytics
It was also top quartile returning 0.4 per cent in the only falling market over that time, 2011.
Harrison and Colwell count FTSE 100 blue-chips such as AstraZeneca, GlaxoSmithKline, BT Group and Royal Dutch Shell as top 10 holdings. The fund yields 3.4 per cent and its clean share class has an OCF of 0.81 per cent.
