Downside protection

Gimme shelter

As the bear market for bonds and corresponding volatility in equities escalates we examine trusts that offer excellent capital protection..
Last update 28 February 2018

The original essay plan for this article was put together in January, and so it is with an unpleasant mix of irritation (because we didn’t publish it sooner) and impotent smugness (because we told you so... only we didn’t) that we have watched the market volatility in the last weeks. 

Our view for some time has been that after almost nine years of gains and with global stock markets trading at all-time highs – the very broadly evident optimism towards risk assets, which had gripped investors until very recently was somewhat misplaced.

Before the tide turned on the back of US payrolls data a couple of weeks ago, 2018 had seen the Dow Jones and FTSE 100 break out of their historic ranges, and record flows into index tracking ETFs. The economic backdrop in nearly all corners of the world appears stable and, in many cases, is improving (particularly in the US) while central bankers’ extraordinary monetary policies of ultra-low interest rates and money printing, as the FT recently put it“look as though they might actually allow the world economy to take off again without having to endure a crash or a bout of hyper-inflation first”.

But as we have seen since stocks began to tumble in the US, then Asia and Europe, asset prices are not the same thing as the economy. Further, behind all the euphoria, there has been a consistent narrative among more sophisticated investors that a correction is inevitable and probably desirable, and that asset prices have become overly inflated during the ‘endless bull market’, which has driven them forward since the end of the credit crunch. Correlations between equity and bond returns have increased significantly – making each asset class less of a ‘diversifier’ versus the other. Investors could face a scenario where they have few places to hide thanks to a pan-asset class sell-off.

The wild ride markets have had a timely reminder that it makes sense to look for options that can help protect against a downturn. The question is: do they exist? We consider various trusts in the AIC Flexible sector that have in the past proved to protect investors capital during more difficult periods in markets. 

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Current Site Kepler Trust Intelligence is produced by the investment companies team at Kepler Partners and is the UK’s premier source of detailed qualitative research on investment trusts. Absolute Hedge is a market leading UCITS research database providing proprietary research on funds, themes and strategies in the UCITS space. Kepler Liquid Strategies is a Dublin domiciled UCITS fund platform featuring a number of best-of-breed fund managers. Kepler Partners is a corporate advisory and asset raising boutique specialising in the regulated funds market in Europe and investment trusts in the UK.