Using absolute return funds to lower volatility
Picking a fund, or a trust, in which to invest is one thing, pairing it with complementary...
We’ve written extensively about safe haven assets and the best ways to diversify throughout up and down markets; material that has been recycled regularly over the past couple of years as geopolitical events, commodity prices, referendums and elections have caused equity and bond market roller coasters.
The flip side of the coin, however, is that volatility isn’t necessarily a bad thing and there are sometimes opportunities in turbulent times. Protecting your portfolio should absolutely be your first priority but, as we’ve also written in the past, if you buy something that’s cheap, you’ve got a better chance of making money in the long run.
Market volatility―when market prices fluctuate more rapidly and more violently than usual―means there will be periods when certain assets, sectors, or even particular companies are cheaper than they usually are.
If these assets/sectors/companies are still good quality investments whose fundamentals have not changed, you may be able to ‘snap up a bargain’. It can be a good idea to have a ‘watchlist’ of funds or stocks that you have researched thoroughly. When falls do happen, and everyone else seems to be pulling out their money, you may be ready to invest a little extra and get the potential benefits of a bounceback down the track.
Be careful to check what has caused the price drop though – is it just the result of negative sentiment or has something more specific changed, such as a fund manager moving on, a negative company forecast or an economic change like an interest rate move that might make it difficult for that particular investment to perform?
It takes a certain type of investor to have the discipline to buy using this strategy. On the whole, conventional investing wisdom states ‘time in the market’ is key to investing success, rather than trying to ‘time the market’.
What’s more, timing the market is notoriously difficult to do (if it was easy, we would all be rich!).
Figures* show that, over the past 30 years, if you had invested £1,000 and tried to time the market but missed just the best 10 days of market returns, your pot of money would be worth £7,812 compared with £14,734 if you had just stayed invested for the whole period.
Becoming a regular saver instead may be a simpler and less emotional way of investing through volatile markets.
Most of us invest in lump sums, whether it’s a few thousand hurriedly put into an ISA before the end of the tax year or an annual bonus or similar payment. Another approach, however, is to invest smaller amounts regularly – say once a month when you get paid.
This can also be a good way to invest when you’re just starting out and you may be less likely to have a large lump sum at your disposal.
The performance of a stock market overall is not necessarily the same as the performance of a managed fund. This is because active fund managers aim to outperform the markets in which they invest over time.
So, say for example the UK stock market, as measured by its main index the FTSE All Share, grows by 5% over one year. A good UK equity fund manager will have invested only in select companies within that index, which he or she thinks are going to do better than the average 5% return. If they’re right, their fund should then deliver higher returns for their investors.
Likewise, however, many fund managers also have a mandate to lose less when markets are falling, which is also a very important part of building their investors’ wealth in the long term. Say the FTSE All Share falls by 5% over one year. An active manager may still record a drop that year, but it might be by only 2%. Or they might even manage to deliver a positive return.
Investing in an Elite Rated fund can help you to stay invested for the long term. You can buy a core investment such as a UK equity fund and then simply hold it, leaving the timing of stock buying and selling decisions to a professional manager.
*Source: Fidelity, January 2016, using the FTSE All Share.