View more on these topics

Shelter from the storm

Cherry Reynard considers where investors can be safe from volatility

Equity markets may have had a better run at the end of October but the summer months were painful for many.

The areas that have protected capital over the past six months have been both predictable, such as gilts, investment-grade corporate bonds and global bonds, and surprising – Japanese smaller companies, for example. However, just as insurance is always more expensive after an accident, investors are now paying a lot of money to protect their portfolios through these asset classes.

All these traditionally low-volatility asset classes have been equally volatile, even if they have ultimately proved profitable. Is there a solution for investors seeking some protection for their wind-swept portfolios?

Whitechurch investment director Gavin Haynes says the conventional approach of balancing stockmarket exposure with gilts may continue to offer protection. He says: “These two asset classes have tended to work in opposite directions. The rewards in gilts are not compelling but if you believe the doom and gloom scenario, this would be the place to sit.” He points out that the UK’s austerity measures have firmed up the country’s finances and the risk of default is now minimal. S&P has recently reaffirmed the UK’s AAA rating.

But Thames River Capital joint head of multi-manager Gary Potter says part of the problem is that the correlation of most major markets has been high, which has rendered some conventional hedging techniques obsolete. He says: “The focus on this area has exploded with the growth of multi-asset funds. It used to be that if you did not like an asset you did not hold it and simply held cash instead but now there is a desire to make it more complex. We have tended to keep it relatively simple. If we don’t like equities, then we hold cash or sell index futures to bring down the overall equity exposure.”

Saltus partner Dan Kemp says the see-saw approach, where an investor switches between defensive assets and riskier assets depending on his view of the environment, is still an option. It has been used successfully by investors such as Jonathan Ruffer but Kemp adds: “The problem at the moment is that fear assets have become very expensive and therefore the see-saw is broken. If you have to overpay for these assets, the risk increases.”

On the basis that conventional measures to mitigate volatility are less compelling, particularly if the climate improves, Haynes believes the absolute return sector may also hold some solutions. Overall, the sector has dipped by 1.9 per cent over the past six months. It may not be the promised absolute return but it is better than the UK all companies sector performance, where the average fund has dropped by 7.8 per cent.

A number of funds did well during the market volatility, notably those from Kames, Liontrust, BlackRock and Cazenove. Haynes gives the example of Philip Gibbs, whose Jupiter absolute return fund has tended to provide a bulwark against falling markets. Gibbs is notoriously bearish and has positioned his portfolio to benefit from a weakening economic climate. The fund has been weak as markets have risen but has proved its worth in the recent market rout.

Investors could also hedge volatility through the derivatives market but this has some drawbacks. The options market is extremely volatile and, for the most part, very expensive. Kemp says: “If you buy too late, you pay too much.” In other words, investors need to hedge their portfolios when risk levels look relatively low, which is not an easy trick.

Potter agrees that, in all cases, investors need to be careful what they pay for protection against volatility because it can prove very expensive while Kemp suggests volatility in itself may not be the problem. He says: “No one really worries about volatility if it means big gains. They only worry is if they are losing money in a hurry.”

He shares Potter’s opinion that to mitigate sharp pullbacks in the market, the first option for many people would be to hold higher levels of cash. “If you are an investor rather than a short term trader, time is on your side. The Keynesian quote that says the market can stay irrational longer than you can stay solvent generally only applies to over-leveraged investors. Those with cash have a buffer.”

Vertem Asset Management branch principal John Dance says buying an ETF on the Volatility index, the Vix, should provide the perfect hedge against volatility, in theory. They are available, although the main ones are listed in the US. The ETF should go up when volatility rises and therefore make the investor money, compensating for any losses in his main portfolio. Dance says quirks in the pricing of these ETFs mean they have not served as a perfect hedge in the past and tracking error has been significant.

Dance believes an investor’s only real option in the current environment is cash. He says: “Currencies, sovereign bonds and gold have all proved extremely volatile, therefore they do not work to defend a portfolio.”

There is no easy solution to market volatility. Markets have been subject to significant manipulation over the past four years, largely through government invention such as quantitative easing. The increasing politicisation of markets has thrown out conventional analysis. The only truly reliable solutions for investors are cash or patience.

Recommended

2

Which? wants more TSC scrutiny of FCA

Consumer bodies have called for increased Parliamentary accountability for the Financial Conduct Authority. Giving evidence to the Treasury select committee last week, Which? chief executive Peter Vicary-Smith (pictured) welcomed proposals to subject the FCA to National Audit Office reviews. But he said the FCA should be brought within the remit of the Parliamentary Ombudsman and […]

Bill Miller to hand over Value Trust in April

Bill Miller is to step down from running the Legg Mason Capital Management Value Trust and value equity strategies from April 30 next year. Sam Peters will takeover as sole manager of the LMCM value trust and value equity stragies, both of which are US-domiciled, as well as replace Miller as chief investment officer of […]

Spirited response

There are some interesting parallels between events in Europe over recent weeks and the current state of play in the UK mortgage market. Both have been hit by uncertainty and the need to find long-term solutions. No one would pretend the problems of either have been fixed but there are some signs of optimism. In […]

The Rubik’s Cube: China’s policy trilemma

By Douglas Turnbull, Investment Director, Head of Chinese Equities China faces a ‘Rubik’s Cube’ policy trilemma, whereby it needs to sustain a minimum acceptable level of growth, deal with issues such as overcapacity and reform the financial system to make it a far more efficient allocator of capital. Given the contradictory nature of these objectives, […]

Newsletter

News and expert analysis straight to your inbox

Sign up

Comments

    Leave a comment

    Close

    Why register with Money Marketing ?

    Providing trusted insight for professional advisers.  Since 1985 Money Marketing has helped promote and analyse the financial adviser community in the UK and continues to be the trusted industry brand for independent insight and advice.

    News & analysis delivered directly to your inbox
    Register today to receive our range of news alerts including daily and weekly briefings

    Money Marketing Events
    Be the first to hear about our industry leading conferences, awards, roundtables and more.

    Research and insight
    Take part in and see the results of Money Marketing's flagship investigations into industry trends.

    Have your say
    Only registered users can post comments. As the voice of the adviser community, our content generates robust debate. Sign up today and make your voice heard.

    Register now

    Having problems?

    Contact us on +44 (0)20 7292 3712

    Lines are open Monday to Friday 9:00am -5.00pm

    Email: customerservices@moneymarketing.com