As the bull run matures, should you be putting some protection into your portfolio? Jennifer Hill explores safe-haven assets.
Stock markets in the developed world have been on a winning streak for more than 100 months – far longer than the average bull run of 64 months. The S&P 500 has risen nearly 350 per cent in sterling terms, while the FTSE All-Share has climbed almost 200 per cent since both indices bottomed in March 2009.
‘There’s no doubting that the current bull market is looking old, relative to history,’ says Paul Green, an investment manager at BMO Global Asset Management.
But investors who think they can wait until the bull market ends to reduce risk are ‘fooling themselves’, according to Peter Elston, chief investment officer of Seneca Investment Managers. ‘For starters, it’s always hard if not impossible to time,’ he says. ‘Secondly, making drastic changes quickly to portfolios is impractical. It’s much better to gradually reduce equity risk as the bull market matures. It’s like driving a car: one should slow down approaching a bend.’ Seneca IM started to reduce equity risk a year ago, despite thinking the next bear market remains ‘some way off ’.
Last September, Ruffer Investment Company, whose primary objective is capital preservation, reduced its equity weighting from around 45 per cent to 40 per cent – as low as it has been since the company’s inception in 1994 – amid ‘several clear and present dangers to market and macroeconomic stability’. Investment manager Duncan MacInnes says: ‘Politics is dominating the headlines, but the broader context of unsupportable debt burdens, high asset prices, moribund growth and social inequality were keeping us awake at night long before Trump or Brexit.’
So what can investors do? Unlike the run-up to 2007, when ‘safe haven’ assets were out of favour and moderately valued – for example, a Swiss 10-year government bond yielded 3 per cent – today’s investor faces a paucity of options.‘Safe havens, such as the Swiss franc and government bonds, have risen in price along with equities due to global yield compression, and are likely to fall together too,’ says MacInnes.
Historical data show that gold acts as investment insurance, thanks to its non-correlation with other asset classes. In the 2000s, for example, gold posted a compound annual growth rate of 14.5 per cent, while shares were flat at 0.8 per cent. Conversely, in the first six years of this decade, shares produced real gross returns of 5.1 per cent a year, while gold lost 2 per cent a year in real terms, according to an analysis by BullionVault.
This means that a small allocation to gold – Architas investment director Adrian Lowcock recommends 5 per cent – can provide downside protection during market crashes. ‘What we have seen time and again is that adding gold as a long-term investment will help to reduce your losses,’ says Adrian Ash, head of research at BullionVault.
As the bull run matures, some wealth managers have turned to gold. For example, investment manager 7IM had no exposure to gold in the three years to March 2016; today, it has its highest allocation ever. It owns 15.4 tonnes of gold, ahead of countries like Ireland, the United Arab Emirates and the Czech Republic. The manager accesses the precious metal through physically backed passive structures, the Source Physical Goldand iShares Physical Gold exchange-traded commodities (ETCs).
However, rising interest rates – one of the major risks to market stability – have ‘usually proven to be gold’s kryptonite’, hence MacInnes warns there is no guarantee it will offer protection in the next crisis.
Absolute return funds
Financial advisers have been taking risk off the table too, re-positioning client portfolios towards funds that aim to deliver a return in all market conditions. Lowcock at multi-manager Architas suggests having 10 per cent of your portfolio in this type of asset.
Earlier in summer, financial planner Gale & Phillipson decreased equity content by 25 per cent and increased exposure to cautiously managed absolute return funds like Premier Defensive Growth. Cathedral Financial Management undertook a similar change last spring, reducing equity content by 5 per cent and recycling proceeds into what research analyst Shane Bennett regards as ‘true diversifiers’, for example Old Mutual Global Equity Absolute Return.
Other managers, meanwhile, have been employing the kind of protection used in absolute return funds. In May, as market volatility fell and the cost of buying protection reduced with it, Rathbones bought a put option on the S&P 500 covering 25 per cent equity exposure.
‘This is a form of protection that gives us the right to sell a quarter of our equity exposure at a level roughly 5 per cent below where the US index was at the end of May,’ says assistant multi-asset fund manager Will McIntosh-Whyte. ‘If the index falls below that level, we will make money on the put, though it will only mitigate some of the losses we’re likely to see on the equities we own elsewhere in the portfolio.’
Given their closed-ended structure, investment trusts are well suited to investing in illiquid assets or adopting a wealth preservation strategy, as managers need not worry about managing inflows and outflows.
For instance Andrew Chorley, managing director of Financial Planning Wales, has increased exposure to Capital Gearing and Ruffer, two trusts that offer a ‘safe pair of hands’, taking this to 19 per cent for cautious clients. ‘We accept that returns are unlikely to be double-digit, but potential losses should be limited,’ says Chorley.
A bear for the past year, Darius McDermott, managing director of Chelsea Financial Services, favours absolute return funds and alternative investment trusts for his funds-of-funds launched in June. ‘Bonds offer poor value, so we’re seeking cautious diversification elsewhere,’ he says.
Thus, while the VT Chelsea Managed Cautious fund would typically have 40 per cent in bonds and 15 per cent in alternatives, it currently has 6 per cent and 37 per cent respectively. McDermott likes the Foresight Solar and GCP Infrastructure investment trusts. Elston at Seneca also likes infrastructure for its government-backed revenues and inflation-linked tariffs.
Because investment trusts are traded like equities, they too could sell off in a correction – at least initially. ‘But if you want to buy protection at times of market stress and safe haven assets have already jumped in price, that could work in your favour,’ says Fidelity multi-asset manager Bill McQuaker.
Structured products often get a bad rap for being complex, opaque and risky, but since 2000, only nine out of 644 capital-at-risk kick-out contracts linked to the FTSE 100 failed to achieve the defined gains and none matured with a loss, according to CompareStructuredProducts.com.
Long-time advocate Ian Lowes, managing director of Lowes Financial Management, says: ‘This is an investment area that few advisers utilise, but you can be pretty certain that it’s where those who know the sector well invest their money.’ He favours ‘less racy’ contracts that aim to return 6-10 per cent a year. The Mariana 10:10 Plan (Option 2), for example, aims to return 8.5 per cent a year, kicking out as early as the plan’s second anniversary provided the FTSE 100 has risen. If it falls and doesn’t recover within 10 years, the plan should return the original capital provided the index is not down by more than 30 per cent on its initial level, in which case it will simply track the fall in the index.
Other plans offer more modest returns, but produce gains even if the index has fallen. Geordie Bulmer, an adviser at Aisa Professional in Wiltshire, gives the example of the Investec FTSE 100 5-Year Deposit Plan 4, which pays 3.7 per cent a year if the index is within 95 per cent of its starting point.
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