Diversify your exposure

NAVIGATING market volatility is always tough for any fund manager seeking to generate alpha and the ongoing sovereign debt and banking crisis in Europe has been a definite test of managers’ mettle.

Recent data shows that worried investors have been redeeming assets held in funds. Outflows from European equity funds in the week ending 19 May have been the worst since April 2008 and investors redeemed a net $3bn from high-yield bond funds in the second and third weeks of May, according to EPFR Global, which tracks fund flows.

So where have these investors been reallocating their cash? The EPFR Global data indicated that the primary beneficiaries of the Greek debt crisis were US bond and commodity funds, both of which are perceived to be a refuge from the storm currently engulfing Europe. For example, in the week ending 19 May, commodity funds received inflows of more than $1bn as investors fled to the safe-haven of gold. Castlestone Management’s chief executive Angus Murray reckons that the precious metal will reach $2,400 in the next decade, spurred on by sovereign debt crisis.

Castlestone says: “Precious metals investments have historically shown to be an insurance when added to a diversified portfolio, acting as a safe-haven asset in times of turmoil.”

This reallocation suggests that institutional investors are increasingly keen to make their portfolios market-neutral, spread the risk and hedge against volatility. Joshua Spitz, head of European index derivatives trading at Barclays Capital, says he has seen significant investor appetite for the new iPath VSTOXX short-term futures exchange-traded note, which allows investors to hedge against European equity volatility.

The volatility has also made equity fund managers more cautious, says Peter Fuller, lead analyst on European equities funds at S&P Fund Services.

But he points out that fund performance has polarised between broadly defensive funds with significant large-cap exposure – as would be expected – and dedicated small-cap portfolios which, as of mid-May, seem to be hanging on to their earlier gains.

Peter Toogood, director of investment services at OBSR, a Morningstar company, advises: “Investors will need to be opportunistic and should favour a barbell of good value, defensive growth stocks, high yielders and industrials all with exposure to growth markets.”

Diversification is back in vogue.