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Seeking the safest alternative
By Fiona Hamilton
With the financial crisis reaching new depths, investors may be tempted to abandon the stockmarket. One problem with this is identifying a genuinely safe alternative. Another is that the eventual market turnaround could be rapid and shy investors could easily miss out. So it could make sense to move some assets to a fund where the manager can significantly restrict his equity exposure while things remain uncertain, but then reinvest once things have settled down. This points to the Balanced Managed sector.
Balanced managed funds never hold more than 85% in equities. In comparison, most equity-oriented funds aim to keep their equity exposure above 80%. Balanced managed funds are also less volatile because they must have at least half their portfolio in the UK or Europe rather than emerging markets. However, they must hold at least 10% in non-UK equities so as to provide some diversification.
As the chart demonstrates, the restrictions on equities meant the average balanced managed fund lagged the FTSE All-Share index during the 2003-2007 bull market, but has held up better than the index over the past 12 months. The funds in the table all did well within the sector during the bull run but, as we noted in the August 2007 (Funds to surf in choppy waters), both New Star funds had a lower capital preservation score (one out of a possible five) than the CF Ruffer European fund, which has a score of four. This was a warning that they might be less resilient in a downturn, and so it has proved.
When considering which funds to support, it helps to focus on how much they favour an absolute or relative return remit. An absolute return remit means the top priority is preserving capital in a downturn, even if this means missing some of the upside when things are going well. This approach is epitomised by the Ruffer fund.
This performed well during the bull market, thanks to its focus on smaller European companies, but also held up exceptionally well in the downturn because it slashed its equity exposure from about 75% to 50% in autumn 2007, and currently has around 55% in cash.
A relative return remit means the top priority is outperforming a benchmark index. This approach is favoured by the majority of funds in the sector, including New Star Balanced Portfolio, and the more adventurous New Star Managed Portfolio. The two funds have raised their cash levels to about 25% and 40% respectively, but their manager Craig Heron is watching for a chance to start dripping funds back into the market once the authorities have "unlocked the credit markets". "If they don't succeed," he says, "we could be in for a decade-long depression."
Heron adds: "Our main objective is to beat the average fund in the sector. Returns from equities have been good over most three, five and 10-year periods, and while our relative return approach may increase our volatility in the short term, it will produce better long-term returns than an absolute return approach."
Both New Star funds are funds of funds, channelling their investments through exchange-traded funds (funds consisting of a number of securities that together track like an index but trade like a stock) and hedge funds, as well as a mix of international equity funds. This adds to the cost, but means they are widely diversified.
The financial turmoil has made diversification much less successful than usual, but if things settle down it could provide added stability and money-making potential.
The giant Newton Balanced fund has been one of the steadiest performers in the sector. Manager Iain Stewart says it has a relative return remit, and is therefore only 25% liquid. He has sought to safeguard the fund's assets by backing a spread of large well-managed companies, which should survive the financial crisis and continue to pay dividends. This has meant steering clear of banks and property, and opting for healthcare and telecoms.
"We've never had a global financial panic like this before," Stewart adds. "I don't want to buy into the market as a whole, but intend to increase my exposure to selected stocks - a lot of good companies have been sold down recently in order to raise money."
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