Too much bounce

I could do without a repeat performance and the current consensus is that the economic backdrop will be better. Muddling through the journey back to growth of a rather feeble kind is what market scribblers forecast for 2013. We can expect no more of the developed world's democracies. Still, if recovery of a sort materialises, then January's 5 per cent gain might have risen to 8 per cent or 9 per cent by the end of the year.

In other words, 2013 could turn out to be another good year for my global fund, after the 9.4 per cent return it posted in 2012. Still, do I want too many 'good' years like those? Recall that the aims of the Bearbull Global Fund is - with limited portfolio churn - to generate steady returns with minimum volatility.

What values we might ascribe to 'steady' and 'minimum' is subjective. When I launched the fund two years ago I reckoned annual returns averaging about 6 per cent - ie, usefully more than likely UK inflation - would be fine. I would stick with that. I also spoke of standard deviation (ie, variation around the average) of not much more than 6 per cent.

I can't quite believe I wrote that. Any equity-dominated portfolio was never likely to produce such docile performance. If 6 per cent was the target return, then, given a high proportion of equities, a standard deviation of 12 per cent would be placid and 18 per cent would be likely. That's how it is with equities - their prices bounce around more than even experienced pundits expect.

Just two years on, there is not enough data to draw conclusions about the global fund's risk/return characteristics. Still, its returns have lurched around more than I would have liked, prompting two questions: does it matter? And if so, what should I do about it?

Perhaps the effects of volatility have more impact in the early stages of a fund's life than when it's well-established. Take the events of late summer 2011 as fears for the euro's survival escalated. In July, August and September, the global fund lost 14 per cent of its value and by the end of September had just £91 of capital for every £100 at its launch nine months earlier. To be so far below its starting value so quickly seemed like a blow from which the fund might never recover. That made the impact of the losses far worse than if the fund had lost 14 per cent when its value had climbed to, say, £200. Yet a 14 per cent loss is the same whenever it strikes. So the effect of taking the fund's value below its launch value was only a psychological blow and, as such, easy to rationalise away.

Still, if I don't want to sustain 14 per cent losses over any three-month period I must address the fact that 63 per cent of the fund's value is linked to share prices via exchange traded funds that track equity markets. That means prices of two-thirds of the fund's holdings by value will bounce around together; not in lock-step, but in the same direction and on roughly the same scale.

The solution means holdings more assets that won't move with equities. So it could mean putting more capital into non-sterling currencies. It really should mean sorting out - for once and for all - the fund's holding in cocoa, whose price falls regardless of the idiosyncratic factors that might favour cocoa. It might mean paying more attention to property, a major asset that has no presence in the global fund. It might even include paying more attention to fixed-interest securities; though that will not - repeat, will not - include government bonds (unless I can find a way of shorting them). To be continued.