How defensive funds are faring as shares and bonds fall in unison

Some funds that are cautiously managed have struggled of late. Kyle Caldwell drills into the data and explains why. 

While there’s still a couple of months to go, it’s looking like 2022 will go down in history as one of those rare times when shares and bonds uncoupled, leading both to post negative returns.  

Normally, when share prices fall sharply over a short time period the defensive qualities of bonds shine through. It is the reason why, historically, the 60/40 portfolio (60% in shares and 40% in bonds) has served investors well.

However, so far in 2022, the average global equity fund (to 15 September 2022) is down 8%, while the average global mixed bond fund has lost 5%.

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Bonds have fallen at the same time as shares because of an unusual occurrence where interest rates have been increased to control inflation, despite a slowdown in economic growth.

High levels of inflation and interest rate rises are both headwinds for bonds. Because bonds pay a fixed income, the real value of that income is eroded more when inflation is high. And when interest rates go up, it means investors can get a better deal from cash savings or newly issued bonds. As a result, bond prices fall.  

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The poor showing from bonds year-to-date means some defensive funds have struggled to live up to their name.

Low-risk multi-asset funds

In theory, multi-asset funds, owing to their greater levels of diversification, should be better equipped to weather a market storm than equity funds investing globally or in a particular region.

However, some funds have not performed in line with expectations so far this year. The ‘safest’ of the four multi-asset sectors – the Investment Association (IA) Mixed Investment 0-35% Shares sector – would usually be expected to protect capital best when stock markets are volatile, due to having only a small weighting to shares.

Year-to-date, the sector has produced the biggest losses, as the table below shows. The more held in bonds by multi-asset funds, the bigger the losses in 2022.

The best-performing multi-asset sector so far this year is Flexible Investment. Funds in this sector have no constraints regarding their exposure to shares. Even when stock markets have been weak, such funds have managed to lose less than other multi-asset funds.

Over the long term, for example, a five-year period, it would be expected that the Flexible Investment fund sector would outperform the other three sectors, which are restricted to owning a certain amount in shares, and this has indeed played out.

*Data to 15 September 2022. Source: FE Fundinfo. Past performance is not a guide to future performance.

Volatility managed and targeted absolute return

Two other defensive sectors are volatility managed and targeted absolute return. Neither have great reputations, and the former hasn’t done much to change that year-to-date. The average volatility managed fund is down 8.6%. Such funds target a specific risk or volatility outcome.

The targeted absolute return sector has held up well, with the average fund down 0.8%.

Since the start of the year, the best-performing fund is up 43.3%, and the worst performer is down 15.9%. Just over a third of funds in the sector (34 out of 101) have produced a positive return.

The problem is that some funds in the sector are aggressive (shorting stocks, for example), while others are more plain vanilla in attempting to deliver slow and steady returns.   

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Absolute return can mean different things to different people, as the definition tends to be based around the end result (“positive ‘absolute’ returns” is a common objective), rather than how the fund manager attempts to deliver this. Therefore, investors need to know what kind of journey they are going on, and whether they are cut out for the ride. So, looking under the bonnet is key to understanding which strategies are being used by the fund manager.

Capital preservation-focused investment trusts

There are a handful of wealth preservation investment trusts that prioritise protecting investor capital. Therefore, when there’s a stock market sell-off, such trusts should keep losses to a minimum.

Four trusts that meet this description are Capital Gearing (LSE:CGT), RIT Capital Partners (LSE:RCP), Ruffer Investment Company (LSE:RICA) and Personal Assets (LSE:PNL). Each has a low weighting to equities and plenty of defensive armoury, such as low-risk inflation-linked bonds and a small weighting to gold.

Year-to-date, three of the four trusts have held up well; Ruffer is up 1.7%, while Capital Gearing and Personal Assets have made small losses of 0.9% and 2.7%, respectively, in share price total return terms.

RIT Capital Partners, however, has seen its share price decline by 15.8%. As our recent analysis of the four wealth preservation trusts explains, RIT Capital Partners has a notably higher amount in equities than its rivals – around two-thirds of the portfolio. Some of this exposure is to unlisted companies. Therefore, it is not a surprise to see that its shareholders have a bumpier ride when stock markets are out of form.

In addition, RIT Capital Partners publishes its net asset value only once a month, which can create some uncertainty over the valuations of the underlying holdings.

Ruffer has just 16.4% in shares, while Capital Gearing and Personal Assets have 39% and 31%. Capital Gearing’s exposure is a mix of funds and equities.