Weathering the storm of equity market volatility

The right funds will help ride out ups and downs

IN COMMON with a global drop in share prices, the FTSE 100 has fallen by 3 per cent since the end of May. Yesterday, it dropped by 60 points; France’s CAC-40 by 54, and Germany’s Dax by 85. Investors are worried that central banks will withdraw the stimulus measures that have propped up the stock market rally of the past six months.

So Adrian Lowcock of Hargreaves Lansdown is right that novice investors, who have turned to shares in search of income, are facing their first test. As are other investors, who have enjoyed four years of virtually uninterrupted gains. But these stomach-churning ups and downs should be put into perspective. The FTSE 100 has risen 18 per cent over the past 12 months. And an investor buying units in the Fidelity Special Situations fund when the FTSE 100 was at its peak on 30 December 1999 would have seen returns of 323.9 per cent (to 31 May 2013), beating the FTSE 100 total return of 49.97 per cent (with dividends reinvested) 6.5 times.

Unsurprisingly, on a total return basis the highest returns have been from Japanese equities, where authorities have been enacting a huge monetary and fiscal stimulus package to kick-start the economy to try and achieve a target of 2 per cent inflation. The Legg Mason Japan Equity A fund, which was the top performer from 1 January to 31 May this year, has seen its value grow by 66.64 per cent. But investors should tread carefully: the region has fallen further than the UK market in recent weeks. “Investors should be wary of funds that shoot ahead in strongly-rising markets as they tend to be more volatile and can fall back just as quickly,” says Lowcock.

On a relative basis, it has been a strong period for a number of energy-themed funds. “Investec Global Energy, Jupiter Global Energy and BlackRock World Resources Income have delivered double-digit outperformance compared to their most commonly-used benchmark – the HSBC Global Mining Index,” says Jason Hollands of BestInvest.

But Nick Peters of Fidelity thinks it is difficult to nominate one particular type of fund that has performed well. Instead, he recommends investors identify fund managers whose process they understand, and who have long-term track records. One trend he does note, however, is the shift from growth funds – where investors put their money in high-quality businesses, with strong cash flow and which have seen success over the past three years – to value funds, which have “performed poorly over the past few years but are now coming back into fashion”.

Peters thinks an active fund manager is worth the extra cost. An active manager does not have to buy the top 100 companies, or an index. The cheapest option, however, remains to use a tracker or passive vehicle, that will track the market while incurring a small fee. But if you match the market, that small fee will mean you could still under-perform relatively.

Whatever your approach, saving small amounts on a regular basis will “combat the natural tendency to sell when markets are low and buy when they are high,” says Tom Stevenson of Fidelity. If you’re a nervous investor, or need access to your capital over a shorter-term timeframe, Hollands recommends absolute return funds such as Standard Life Global Absolute Return Strategies, or Insight Absolute Insight. “They are designed to generate steady returns, but with low capital volatility,” he says. Peters likes the Majedie UK Equity Fund, a blended fund that performs well across the investment cycle, as one to top up at the moment.

He sees current movements in the stock market as an opportunity to drip money into the funds investors like, “rather than wholesale selling or panicking out”. Indeed, trying to time the market will often lead to heavy losses. The top-performing funds in May “are highly volatile, high-risk, and may appear at the top one month but at the bottom the next,” warns Lowcock.

Looking forward, Lowcock recommends pinpointing companies with strong cash flow, that are paying out a good dividend. Hargreaves Lansdown likes equities over the medium and longer-term, with Japan and Europe remaining the cheapest of the major regions.