It is crucial that investors create a portfolio that can cope with multiple possibilities if they are to avoid falling foul of unexpected events.
Diversification through the main asset classes is the usual route, but institutional investors usually add more sophisticated techniques to their arsenal.
Derivatives, most notably strategies that make money if assets fall, are key tools for the money managers’ money managers.
Although many retail investors shun these instruments as an over-complication, there are a number of highly regarded retail funds that have used them to good effect.
Artemis Strategic Assets
The £881m Artemis Strategic Assets fund, which is run by William Littlewood with Giles Parkinson, sits in the IMA Flexible Investment sector and has a wide remit that allows it to hold all sorts of assets.
Darius McDermott, managing director of Chelsea Financial Services, says the way the fund uses derivatives is central to its proposition.
"They are trying to keep up with rising markets and to have some downside protection too, and there are a number of ways that they do that," he said.
"It’s not just an equity fund but also commodities, currencies, fixed interest and it can be short any of those assets at any time."
"It’s unlikely he will be net short equities. It’s a net long product but he does short some stocks he dislikes. He will short some currencies and government bonds."
"William’s track record was from Jupiter Income in the 90s, and then he ran a hedge fund for a small number of friendly individuals."
"This is more akin to a hedge fund, but not offering absolute downside protection which is why it’s not in the absolute return sector."
"You would expect it to underperform slightly in bull markets but outperform in down markets."
Data from FE Analytics shows that Artemis Strategic Assets has performed roughly in line with the average fund in the IMA Flexible Investment sector over three years, with marginally less volatility.
The fund has made 20.46 per cent over that time while the sector has returned 23.14 per cent, according to data from FE Analytics.
Such comparisons are of limited use, however, given the wide variety of funds in the Flexible Investment sector.
Performance of fund vs sector and benchmark over 3yrs
Source: FE Analytics
The fund was launched in May 2009, so the only down market it has seen was that of 2011.
In that year the portfolio’s hedging could not prevent it losing 7.62 per cent, which compares with the 2.32 per cent loss of the FTSE APCIMS Growth index it takes as its benchmark and the 3.46 per cent lost by the FTSE All Share.
The fund requires a minimum initial investment of £1,000 and has ongoing charges of 1.6 per cent.
Old Mutual UK Dynamic Equity
Old Mutual UK Dynamic Equity is a £237m mid cap fund with five FE Crowns. It is run by FE Alpha Manager Luke Kerr.
Kerr speaks with the Old Mutual analysts to gather their best ideas, which he selects for his fund, and he shorts selected stocks the team expects to fall in value.
The fund can have up to 30 per cent in short positions at any one time, but the amount of such positions has been falling in recent months.
Although the proportion has been higher, the fund currently has only four short positions, worth 1.5 per cent of the fund.
The manager told FE Trustnet last month that the improving macro situation was positive for markets and made taking short positions less appropriate.
Performance has been strong recently, with the fund sitting in second place in the IMA UK All Companies sector over three years.
The fund has benefited from being in the strongly performing mid cap sector, but it has significantly outperformed the FTSE 250 benchmark too, making 84.48 per cent compared with 61.39 per cent from the index.
Performance of fund vs benchmark over 3yrs
Source: FE Analytics
Its volatility over that time has, however, been marginally higher.
Old Mutual UK Dynamic Equity requires a minimum investment of £1,000 and has ongoing charges of 1.75 per cent.
Newton Real Return
FE Alpha Manager Iain Stewart’s £7.8bn Newton Real Return fund sits in the IMA Absolute Return sector, making it less surprising that it uses derivatives extensively.
The fund holds a variety of assets, but has 61.2 per cent in equities, and uses options to hedge against the risk of market falls; it currently has an option on the S&P 500 worth 16.5 per cent of the portfolio.
It also takes currency positions to hedge risk and is currently positioned long the US dollar. Stewart remains cautious about having exposure to sterling, and hedges any European equity exposure.
The absolute return sector has had a bad press over the years, as many funds have failed to provide steady real returns.
With the exception of 2011, when it lost just 0.75 per cent, Newton Real Return has made money in every year since it was launched in 2005.
Data from FE Analytics shows that it has beaten its benchmark of one-month GBP Libor plus 4 per cent since launch, making 88.03 per cent for investors over that time.
Performance of fund vs sector and benchmark since 2005
Source: FE Analytics
FE Research analyst Charles Younes says that the fund makes an appropriate core holding for a retail investor, although he flags up two concerns.
"Its only significant weakness is the proportion of institutional investors that hold it: Newton has a privileged relationship with its clients and their turnover is low, but if one large investor was to sell its stake, this could seriously damage the value of the fund," he said.
"One additional risk is the fund’s use of derivatives; Newton’s expertise in these complex instruments gives the fund a real edge, but they can also cause real damage if not handled properly."
The fund requires a minimum investment of £1,000 and has ongoing charges of 1.12 per cent.