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Defensive difficulties

With traditional defensive asset classes not providing the same protection, what strategies are firms turning to for downside protection?

With the value of holding gold and government debt being called into question, it is clear the traditional defensive asset classes are not providing the same protection that they used to.

As equities continue to rally, and with correlations high across the asset classes, it has become harder to find downside protection. Given this backdrop, it is interesting to note the different strategies being employed across the industry to provide downside protection.

Joe Le Jehan, a member of the Cazenove Capital multi-manager team at Schroders, has opted to use cash and hedge funds as a buffer. He says: “The problem we have found is there are not any bearish managers out there. The likes of Hugh Hendry and his Eclectica fund are some of the last bears out there, and even he is getting a bit more positive about things.”

Three Counties IFA Andrew Alexander is attracted by the underlying assets of structured products within one of his chosen funds, thanks to what he sees as a degree of capital guarantee.

He says: “To protect our funds we have added exposure to the £143m Brooks Macdonald Defensive Capital fund, co-managed by Jonathan Gumpel and Robin Eggar, which I have held for over two years. The zeros and split caps in the fund add an element of capital guarantee so you can calculate how much capital will come through. It means the fund will not fall as much as the markets if they tank.”

Rathbones Multi-Asset Portfolios co-manager Mona Shah has gone for put options which she sees as a good way to protect against volatility.

She says: “We still hold put options across all of the strategies, and longer-dated government bonds for the Total Return and Strategic Growth portfolios only. We have chosen this tactic to mitigate portfolio volatility should equity markets fall; however, since buying the bonds in January as a hedge, their subsequent rally has meant we have now taken profits.”

Vertem Asset Management co-founder Gary Stockdale has been putting in place downside protection with equities, identifying stocks that look to be good value despite the current rally.

He says: “This starts with ensuring portfolios are exposed to stocks which have been identified by our research process as trading at a discount to their intrinsic value. Alongside this, we have sought exposure to strategies that write covered call options while also tactically deploying put options with the intention of outperforming in choppy sideward trending markets.”

Cannaccord Genuity Wealth Management multi-manager Justin Oliver recognises that investors may not want to put “all their defensive assets in one basket” and is looking to diversify across several strategies.

He says: “One such area is infrastructure, where many closed-ended investment trusts in the sector have displayed these correlation characteristics, while delivering an attractive, inflation adjusted income stream.

“The other strategy has been to target fund managers who have sufficient flexibility such that they are able to capitalise on either rising, or falling bond yields and who have demonstrated an ability to deliver returns which are independent of bond and equity movements.“

City Financial head of multi asset Mark Harris has been using heavily hedged hedge funds but is also concerned about equity exposure.

Harris says: “I am also using derivatives to protect the portfolio, reducing exposure to equities. I do see that markets have travelled a long way and that sentiment is at extreme optimism levels. My suspicion is we are overdue a correction. I have bought some puts which protects about a third of my UK equity exposure.”

But in contrast, F&C Investments multi-manager Gary Potter is more bullish. He says: “We have had five years of downturns and volatility, and in my opinion the global economy is starting to get some traction. In my view, cash provides better protection than bonds.”

Chelsea Financial Services managing director Darius McDermott admits it is difficult to find a defensive asset in today’s environment. He says: “You can always sell things and put a bit more into cash, or you could go out and buy some index downside protection. You always have to judge the markets as they are today but you would not want to be fully invested at the moment.”

Hargreaves Lansdown senior investment manager Adrian Lowcock believes investors need to think about what would happen in a worst-case scenario.

He says: “The question that needs to be asked is, where would the money flow if there was a crisis? It would probably flow back into more traditional defensive areas such as government bonds. There has to be an acceptance that there are still risks in defensive assets, so potential returns will need to be sacrificed in favour of protection. It all comes down to attitude towards risk.”


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