David Prosser explores how defensive investment companies have been able to preserve investors' wealth throughout difficult times.
Here’s a quiz question for you. Which investment fund is up by close to 10% this year, despite the setbacks we’ve seen on world stock markets, repeating its achievement of confounding the downturns of the past?
The answer is Ruffer Investment Company, which gained 9.5% over the first four-and-a-half months of 2022. It also delivered a positive gain over the six weeks in the spring of 2020 when markets crashed as the Covid-19 pandemic took hold. And going further back, it delivered strong returns over the two years that the world was shaken by the global financial crisis.
How has Ruffer pulled off this trick? The short answer is that the fund’s managers have made some very smart decisions. Currently, only a third of assets are invested in global stock markets, and those holdings largely consist of defensive stocks, as well as the oil giants Shell and BP, which have seen earnings soar in recent months courtesy of rising energy prices.
Instead, Ruffer currently holds a healthy chunk of lower-risk assets including bonds and cash, and a quarter of the fund is in alternatives. This latter segment includes some clever trades in the interest rate options market, which have paid off handsomely as central banks have tightened monetary policy.
The key point about Ruffer is that it is one of a small number of funds with an unconstrained investment policy. Its mandate is to preserve wealth, rather than to offer investors exposure to a particular asset class. The management team largely has the latitude to pursue that goal in whichever ways it sees fit.
Other funds that take a similar approach include Capital Gearing, Personal Assets and RIT Capital Partners. Indeed, the AIC Flexible Investment sector includes around 25 funds where the managers have this kind of freedom.
That is not to say, of course, that each of those funds will save investors’ bacon during troubled times. Their ability to ride out the storm depends on the decisions their managers take – and therefore the skill and experience of those managers.
Equally, these funds may not be the most exciting places to be in a rampant bull market. Just as managers don’t throw the baby out with the bathwater in troubled times, typically retaining at least some equity holdings, they don’t go all in when markets are rising - their portfolios will remain varied.
However, what you do get with these investment companies is a one-stop shop for asset allocation. Investors and advisers don’t have to make a decision for themselves about whether, say, to dump equities as the outlook darkens; with Flexible sector funds, managers have the room to make those choices.
It’s a reminder of one drawback to the conventional approach to picking investment funds. In any single asset class, investors in even the best funds are likely to lose money if that asset class tanks. The fund may be actively managed – rather than following the market down automatically like a passive investment – but it’s unlikely to be able to avoid an asset class-wide correction. Investors’ only option is to move their money out of the fund altogether.
In this context, maybe Flexible sector funds could be the ideal core holdings for investors. Many advisers swear by a model that puts most of clients’ money into a small number of relatively plain vanilla funds – the core of the portfolio – with smaller sums then allocated to more eclectic and potentially more rewarding options. The plain vanilla funds in such models are often very conventional stock market vehicles, offering exposure to mainstream equity markets. Unconstrained investments are certainly worth considering as an alternative.