The consensual view is that the US Federal Reserve will raise interest rates this week for the first time since the global financial crisis which should bring to an end the uncertainty which has dogged markets for some time now.
Of course, there is always the chance Janet Yellen and Co. will continue to “kick the can down the road” in relation to tighter monetary but most traders (76 per cent, according to Bloomberg) are factoring in a 0.25 per cent increase the Fed’s fund rate on Wednesday.
While it is a very small figure, an increase in the risk-free rate could have implications for all asset classes – especially given that most have flourished in the very loose conditions of the past six or so years.
Performance of indices since the global financial crisis
Source: FE Analytics
Jason Hollands, managing director of business and communication at Tilney Bestinvest, says that volatility will be inevitable if the Fed does raise interest rates but says certain asset classes will be hurt more in such an event.
An area he says investors should largely steer clear of, for example, is the US equity market as the S&P 500 has posted gains in every calendar year since the crash thanks to the easy monetary conditions.
He also warns that this rate hike is likely to occur as most investors are concerned about the outlook for the Chinese economy, which has been a perennial source of bad news for investors over the past year.
In this article, though, Hollands highlights five funds which he believes will serve investors well if we finally have a ‘lift off’ in the US.
Invesco Perpetual Global Targeted Returns
Given the bull run in developed market equities is stuttering, bond yields are expected to rise and uncertainty about the economic backdrop has increased, Hollands says investors may wish to focus on more cautious funds in the event of a US rate hike. 
“Cautious investors might consider absolute return funds that aim to generate positive returns in all market environments and with low volatility,” Hollands (pictured) said.
There are a number of funds Hollands uses within this space, but one of his favourites is Invesco Perpetual Global Targeted Returns.
The now £4.2bn fund was launched in September 2013 by David Millar, Dave Jubb and Richard Batty who all moved to the group after previously managing the hugely popular Standard Life Investments Global Absolute Return Strategies (GARS) fund.
By investing across a variety of asset classes and blending strategies, the team aims to deliver a return of 5 per cent per annum above the UK three month LIBOR of a rolling three year period, with roughly half the volatility of global equities.
According to FE Analytics, since its launch Invesco Perpetual Global Targeted Returns has returned 12.46 per cent. This means it has comfortably outperformed the FTSE All Share, but is behind the Barclays Sterling Gilts Index which has made 17.43 per cent over that time.
Performance of fund versus indices since launch
Source: FE Analytics
Nevertheless, the Invesco Perpetual fund has had a lower annualised volatility and maximum drawdown than bonds and equities since inception. Invesco Perpetual Global Targeted Returns has an ongoing charges figure (OCF) of 0.87 per cent.
Powershares FTSE RAFI US 1000 UCITS ETF
Hollands is fairly bearish on the US in the face of an interest rate hike.
He warns that share prices have raced ahead of corporate profits over recent years, the market as a whole looks expensive and a strengthening dollar is likely to hurt US exporters. However, he says there are certain areas which could look attractive in a higher rate environment.
“Investors who hold their exposure to the U.S. market through low cost S&P 500 index trackers, as many do, might revisit this,” Hollands said.
“While there is a lot of sense in this approach on a long-term view, if the U.S. bull-run is running out of steam, these funds will be less appealing and also very vulnerable to any correction. Investors might therefore wish to use funds that are more sensitive to a company’s valuation.”
The instrument he likes is the $250m PowerShares FTSE RAFI US 1000 UCITS ETF, which is a smart beta exchange traded fund.
“It invests in the 1,000 largest companies but rather than weighting exposure to each on the basis of its size, it does so on a combination of fundamental attributes (revenue, cash flow, dividends and net assets on the balance sheet) which means it combines the benefits of passive investing (low costs, diversification) but leans away from more expensive, speculative companies in favour of more robust and reasonably valued ones,” he said.
Over the last five years PowerShares FTSE RAFI US 1000 UCITS ETF has returned 65.42 per cent in sterling terms, which is some 20 percentage points lower than the gains of the S&P 500. However, its value tilt (given the style has performed so poorly relative to growth) has led to that underperformance.
PowerShares FTSE RAFI US 1000 UCITS ETF has an OCF of 0.39 per cent.
Threadneedle European Select & Baring Europe Select
Its seems that 2016 will be a very different year to those investors have witnessed recently as most expect a divergence in monetary policy on the part of the world’s central banks.
That is because while the Fed is likely to raise interest rates, the ECB and Bank of Japan should continue pumping liquidity into the system via their respective quantitative easing programmes. Hollands says, as a result, European equities look particularly attractive at the moment.
“Across developed equity markets we prefer Europe,” Hollands said.
“Despite the European Central Bank leaving markets somewhat underwhelmed by its recent announcement that it would extend its QE programme (markets had hope for more aggressive moves), Europe still has loose money policies in place, with the scope to do more.”
“Also, as the eurozone is a net importer of oil and gas, continued low energy prices provide an additional economic boost to both businesses and consumers.”
Hollands’ two favourite funds in the space are Threadneedle European Select and Baring Europe Select.
The former is £3bn in size, has a large-cap tilt and has been run by FE Alpha Manager David Dudding since July 2008. According to FE Analytics, it has been a top decile performer in the IA Europe ex UK sector over that time with returns of 104.71 per cent, meaning it has more than doubled the gains of its FTSE World Europe ex UK benchmark in the process.
Performance of fund versus sector and index under Dudding
Source: FE Analytics
The £1.3bn Baring Europe Select fund, on the other hand, sits in the IA European Smaller Companies sector and is a higher beta offering.
FE data shows that, under the stewardship of Nicolas Williams, it has comfortably outperformed both its sector and the Euromoney Smaller Europe ex UK index over 10 years with returns of 203.08 per cent.
Threadneedle European Select and Baring Europe Select have OCFs of 0.83 per cent and 0.81 per cent respectively.
Finally, Hollands says investors can afford to be more bullish on the developing world once the Fed starts to raise interest rates.
In truth, the uncertainty over monetary policy in the US has been one of the primary headwinds facing the emerging markets, along with concerns over the future of China’s economy and the recent falls in commodity prices.
The MSCI Emerging Markets index has posted significant losses this year and Hollands points out that the prospect of tighter monetary policy (which in turn has led to a strengthening dollar) has hurt many developing economies who hold dollar denominated debt. Once there is more certainty in regard to US rates, though, he believes emerging markets will become more in favour.
“Emerging Markets and Asia have been so hammered there comes a point when you have to ask whether the bad news and risk are priced in,” he said.
“Emerging Market equities are valued at around 10.8x their projected earnings which is a discount of around 30 per cent to developed market equities. 2016 could be the year when investors might consider dipping their toe back in with incremental purchases.”
One of his favoured offerings is FE Alpha Manager Nick Price’s Fidelity Emerging Markets fund.
Performance of fund versus sector and index since launch
Source: FE Analytics
According to FE Analytics, it has been a top decile performer in the IA Global Emerging Markets sector since its launch in June 2010 with returns of 18.40 per cent. Its MSCI Emerging Markets benchmark has lost 5.19 per cent over that time.
Fidelity Emerging Markets, which has beaten the index in three out of the last four calendar years and looks set to outperform again in 2015, has an OCF of 1.07 per cent.
