A home in uncertain times

It’s been a long time coming, but the global stock market volatility of recent days was hardly unexpected; for months, anxiety has been building about valuations, particularly in the US, following the extended bull market. It just needed a trigger – in this case concern about monetary policy – to set it off.

Should investment company investors be worried? Well, as the analyst team at Winterflood Investment Trusts warned just a couple of weeks ago, many closed-ended funds are vulnerable to a correction. Their shares have been trading on unusually narrow discounts – and in many cases premiums – to the value of their underlying assets. As sentiment deteriorates, those discounts are likely to widen, exaggerating portfolio losses.

It’s also the case that while gearing has helped investment companies outperform at every stage of the bull market, borrowings count against you when markets are falling. Gearing accelerates losses just as it provides a boost on the upside.

Still, let’s not panic. Discounts are likely to widen, but not excessively – not least because the majority of investment company boards have implemented discount control mechanisms in recent years that require them to intervene if discounts rise above a certain level. Equally, while investment companies have the option of taking on gearing, many funds choose not to exercise it; or they take on tactical short-term debt that is straightforward to unwind.

Moreover, investors who feel uncomfortable with the levels of market volatility we are now seeing probably shouldn’t have money in equities in the first place, including in investment companies offering exposure to this asset class. We do not yet know whether the setbacks of recent days are simply a pull-back from the highs achieved at the end of 2017 or represent a change of market mood that will prevail for some time. Nevertheless, investors must maintain their long-term perspective.

That said, it’s worth pointing out that the investment company industry offers a range of possible defences against market volatility.

One is the tried and trusted regular savings scheme, through which investors can drip-feed money into the markets – as little as £25 a month for some funds. Investing in this way gives investors access to the pound-cost averaging effect – the fact that a fixed, monthly cash sum buys more shares in months when prices are lower, providing value as markets recover. You’re essentially smoothing out the worst of the market volatility.

Another option is to take a closer look at the funds in the Association of Investment Companies’ relatively new Flexible Investment sector. The investment companies in this category are much less constrained by mandates that require them to stick to particular asset classes; their managers have much more freedom to position the portfolio in the way they see fit for prevailing market conditions and the outlook ahead. Many of these funds currently have low allocations to equities, particularly more volatile markets.

Similarly, the investment companies universe includes a variety of funds offering little or no exposure to equities at all, ranging from infrastructure to debt. These alternative asset classes may become more popular with investors worried about equity valuations.

It’s also possible that you see the current round of sell-offs as an opportunity. Funds exposed to some of the high-performing technology companies of the US have had it worst, because the excitement around these businesses has pushed up their valuations ahead of the rest of the market. Even so, the long-term fundamentals of such companies are as positive as ever – maybe this is a chance to build further exposure.

Tread carefully – the bottom line is that it doesn’t make much sense for investors engaged in sensible long-term financial planning to try to call the market (or for their advisers to do so on their behalf). But if you do want to tinker with your portfolio in what may be new market conditions, the investment company industry provides plenty of opportunities.