Three out-of-form funds to ‘buy the dip’

Trying to buy the dip and time the bottom with a lump of cash is extremely difficult, but buying good quality investments at a discounted price is a sensible strategy. 

In our commentaries at the end of the last quarter, we noted that over the last 40 years it was only the second time ever that stocks and bonds had fallen for consecutive quarters, and over that time, it had never occurred for three quarters in a row.

Well...it just did, although the tumbling pound meant that UK investors holding global or US equities avoided this outcome, whereas in base currency terms stocks and bonds were down for the third consecutive quarter.

While the fall in stocks has many people worried, it is the rout in bonds that has investors spooked. Equities are supposed to have periods where they lose money, whereas bonds are meant to offer protection against this outcome.

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From its 11 March 2020 high until the Bank of England had to step in to keep some liability driven investment strategies liquid on 27 September 2022, UK gilts lost 35%, with 30% of that occurring just this year.

At the same time, the pound has suffered a high-profile devaluation, although it has staged a small recovery after plumbing the depths following the expansionary mini-budget. The dollar rules all in the global currency markets, due to strong interest rate action and an at-times hawkish rhetoric from the world’s most powerful central bank.

So, what happens next? Do things bounce or do they keep falling? Should you start deploying any powder you have kept dry? Unfortunately, there’s no crystal ball and no real precedence for what is going on.

Investment lessons from the 1970s

One period of time we could look at is 1973/1974, a period beginning with low unemployment that then saw rapid oil price rises linked to a war, followed by rapidly rising interest rates. Stocks were hit hard at the end of 1973 and throughout 1974. Investing in mid-1973 would have seen an investor need to stay in the market until the second quarter of 1978 to make it back to level par, although if one could have timed the bottom, returns would have been 72% by the same time. Is it the same this time?

Well, the world is very different than in the early ‘70s, although there are some parallels, the structure of the markets especially is entirely different, with a vast change to the landscape of products and in terms of access to markets for both investors and issuers.

However, in behavioural terms things seldom change, with investors pouring money in on the upside when they believe things are going well only to withdraw at twice the speed when markets sell-off.

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To this end, trying to buy the dip and time the bottom with a lump of cash is extremely difficult, but buying good quality investments at a discounted price should be encouraged. Drip-feeding money into a well-balanced portfolio at regular intervals is a prudent way to lower the average cost of investments (pound cost averaging) and boost longer-term returns.

It is also prudent to reassess what you can afford to lose and what you can emotionally take in terms of losses, as selling in a panic when seeing large red numbers in your account is an easy way to destroy value.

With all this in mind what is there out there that could be added to a diversified portfolio to benefit from the steep drawdowns year-to-date? Naturally with heavier drawdowns many look to the equity space, but there are areas in fixed income where attractiveness has increased too.  

Three falling funds that catch the eye  

TR Property (LSE:TRY) is an investment trust that invests mainly in the shares of property companies rather than physical property. It has seen a share price fall of 41% year-to-date. Of late, the market has been adjusting the “discount rate” for listed assets faster as interest rates rise. While rising rates undoubtedly put valuations under pressure, as have some stock-specific issues for the trust, there’s a large dislocation between listed and direct property. The Direct European Property Fund Morningstar Category has seen a near 5% increase in sterling terms year-to-date.

Another opportunistic option could be short-duration high yield. Funds such as Royal London Short Duration Global High Yield Bond are much less exposed to interest rates, but still provide attractive yields as spreads widen. The fund buys bonds with attractive yields and shorter times to maturity, so the risk of default is reduced. These funds may deliver strong absolute returns after periods of drawdown.

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Another area in which investors may look for value is in the investment trust market, investing in trusts that are trading at a discount, with the caveat of being mindful that the discount could also indicate deeper issues, such as very high levels of gearing or the market disagreeing on the valuation of harder-to-price assets.

An alternative option would be to look for companies where the discount has widened. One such example we would highlight is Montanaro European Smaller (LSE:MTE). This fund looks for small-cap quality growth companies, which has been one of the worst areas year-to-date and the fund has subsequently seen its share price fall more than 50%.

Alongside this, the fund has gone from a small premium to a discount around 13%, despite being a fully listed portfolio with only small levels of gearing. While the strategy and style might be in for short-term pain if markets continue as they are, those willing to hold for the long term would be getting the assets at a discount to their market value, which could boost long-term returns.

Scott Thompson is a senior analyst for manager selection services at Morningstar.