The value of cautious funds has been reiterated this year as a somewhat bearish atmosphere has hung over financial markets.
Returns from UK bonds and equities have been mostly flat – albeit with high levels of volatility – all year with Grexit, the UK election, turmoil in the Middle East, August’s China led sell off and anticipation of a US interest rate rise all adding to a considerably risk-off attitude from investors.
In this article, we take a look at the funds the experts are backing for a cautious view of the year ahead should there be half as much to worry about in 2016.
First up Ben Willis (pictured), head of research at Whitechurch Securities, backs this £339m portfolio – headed by Paul Smith – due to the manager’s ‘very careful’ strategy.
He says despite the fund only having been running for five years, Smith has been running similar low risk strategies for over a decade.
“Unlike other absolute return funds that use a rolling three year basis for their risk adjusted returns, Smith targets cash / inflation plus returns over a rolling 12 month periods,” Willis said.
“All markets and asset classes are considered for the portfolio but many investment ideas are rejected if Smith cannot find the lowest risk way possible of applying it within the portfolio.”
“Given this approach the fund has proven excellent at protecting capital during periods of market and economic uncertainty, which has translated into excellent low risk adjusted returns.”
According to FE Analytics, the fund has returned 18.96 per cent since launch in 2010, beating its sector and benchmark and delivering lower volatility.
Performance of fund vs sector and index since launch
Source: FE Analytics
Among the top holdings in the portfolio are the M&G High Income investment trust and UK equities are the highest weighting in the portfolio, at 21.93 per cent and cash making up 9.3 per cent.
The fund has a clean ongoing charges figure [OCF] of 1.11 per cent.
Next Simon Evan-Cook, senior investment manager at Premier, tips this alternative fixed income portfolio that is popular with fund of funds managers.
“This is a niche bond fund, but given the concerns surrounding liquidity in mainstream bond markets, we think that is no bad thing. It invests in residential mortgage-backed securities (RMBS), which are pools of residential mortgages.
“It contains only the highest-rated securities, which are made up of mortgages with low loan-to-values, and therefore a very low likelihood of default. We expect such a portfolio to survive a severe sell-off in risk assets.”
The fund has a yield of 5.58 per cent, one of the highest in the IA Sterling Strategic Bond sector.
The fund has made 25.03 per cent since launch in April 2010, compared with 4.03 per cent from the Libor GBP 3m index.
Performance of fund vs index since launch
Source: FE Analytics
The fund has a clean OCF of 1.29 per cent.
Meera Hearnden, senior investment manager at Parmenion, argues that in the (now) rising interest rate environment corporate bond funds may struggle and equities are more likely to outperform.
Due to this belief she opting for the $2.4bn Trojan Income fund run by FE Alpha Manager Francis Brooke, for a cautious equity fund emphasising downside protection.
She says although it may underperform in a strong equity market rally “it comes into its own” during more volatile periods.
“There are merits in adding a fairly defensive equity income fund to a cautious portfolio such as the Trojan Income fund. As 2016 is likely to be a challenging year for fixed interest with volatility likely to rise, the Trojan Income fund is an excellent option as it has an inherent focus on downside loss,” Hearnden said.
“Brooke does not invest in cyclical or highly capital intensive businesses, preferring those with sustainable business franchises.”
“This approach has naturally led to less volatility than the peer group, and the fund has shown to deliver stellar performance in more difficult markets.”
Trojan Income has returned 173.71 per cent since launch in 2004, beating its sector and benchmark and delivering the lowest volatility of its peer group, as well as substantially less than the wider UK equity market.
Performance of fund vs sector and index since launch
Source: FE Analytics
It has also grown its dividend in every year since launch. The fund has a clean OCF of 1.02 per cent
Royal London Short Duration Global High Yield
Next Ben Conway, fund manager at Hawksmoor opts for this more specialist high yield fixed income portfolio.
Managed by Azhar Hussain, who has a specific expertise in running short duration strategies going back 11 years, the fund has done particularly well in periods where the broader high yield market has been weak.
His track record includes a strong performance in 2008 where his maximum drawdown was just 3.25 per cent.
Conway says the fund's strategy is to only own bonds that have a relatively short time to maturity often in more niche areas of the markets.
“This enables Hussain to select bonds with relatively low credit ratings and thus high yields. Ratings agencies do not distinguish between bonds issued by the same company but with different maturity dates – the implication being shorter maturity bonds may often have lower credit risks than longer duration bonds.”
“He has a very strict credit selection process and that means he often targets quite small issues – which are ignored by the bond fund behemoths and are undervalued as a result. Thus the fund will never be allowed to gather billions of pounds worth of assets – another reason why we like it.”
According to FE Analytics, the £320m fund has returned 10.41 per cent since launch in April 2013 more than double the IA Sterling High Yield sector average.
Performance of fund vs sector and index since launch
Source: FE Analytics
The fund has a clean ongoing charges figure [OCF] of 0.60 per cent.
Last up Rob Morgan, pensions and investment analyst at Charles Stanley Direct, opts for this portfolio managed by William Littlewood which sits in the IA Flexible sector.
It is a broad portfolio of 110 holdings with 44.7 per cent in equities with most of this in banks and fund management companies. He has also been one of the most vocal bond market bears and has had major short positions in developed sovereign debt markets for a number of years, which has largely hurt performance.
He also has 19.1 per cent in cash and while Morgan says the fund is “unlikely to shoot the lights out”, he thinks it’s more unusual strategy could work well for cautious investors and says Littlewood is both good at stock picking looking out for downside risk.
“Long financials and short government bonds seems like a sensible each way bet to me; and in my view Littlewood’s knowledge of the markets and skill as a fund manager make this fund worth considering as a core position in a portfolio.”
“Littlewood thinks government bonds from countries such as the UK and Japan are simply too expensive given that debts are rising and demographics deteriorating, and that at some stage prices will fall and yields rise.”
“The manager has great flexibility at his disposal with this fund. It has the admittedly difficult aim of beating both cash and the FTSE All Share index over three year periods,” he added.
“He can invest in a mix of shares (usually large, cash generative, dividend paying companies), bonds, commodities and currencies.”
Since launch the fund has returned 52.39 per cent, while the average portfolio in the IA Flexible sector is up 67.21 per cent.
Performance of fund, sector and index since launch
Source: FE Analytics
“Littlewood also believes investors are underestimating the risks of a Chinese slowdown, falling corporate profits and burgeoning sovereign debt. In particular, he believes equities and bonds have an unhealthy addiction to quantitative easing (QE) and ultra-low interest rates, noting that markets tend to rise when further stimulus is anticipated while ignoring issues such as declining profitability,” Morgan added.
The fund has a clean OCF of 0.87 per cent.
