Shock-absorbing funds

Where have all the safe havens gone?

The path to a smooth investment ride used to lie in assets such as government bonds, the US dollar, Japanese yen and gold, but each of these is now facing its own demons. Quantitative easing (QE) has sent stable bond yields crashing into negative territory and the Japanese government's desire to weaken the yen makes it an unappealing choice. Even gold, often described as a 'safe haven' investment, spent 2014 on a rollercoaster price ride and is far from a safe bet.

Absolute-return funds

If your key concern is protecting your capital and maintaining steady returns, an absolute-return fund could be your best option. Rather than trying to beat an index these funds attempt to deliver a consistent positive return, meaning they will not outperform in a bull market but could protect you from shocks when things turn sour.

Insight Absolute Insight (NURS) A Acc (GB00B1SVX910) is a well-diversified fund that has made a positive return every year since 2008. It returned -0.17 in 2008 when the FTSE All-Share fell by 29.93 per cent.

Josh Ausden, head of content at TrustNet, says: "Over the past seven years the fund has returned 35.67 per cent, putting it well behind the index, hardly surprising given that the fund isn't designed to capture upside swings in risk assets. However, the journey has been much smoother for investors, and those worried that markets could take a turn for the worse in future months will be pleased to see how it coped with the 2008 and 2011 crashes."

The fund boasts a maximum drawdown of 3.55 per cent over seven years compared with 42.45 per cent for the FTSE All-Share, meaning investors fared much better than average if buying or selling at the worst possible time.

Darius McDermott, managing director of Chelsea Financial Services, likes Henderson UK Absolute Return I Acc (GB00B5KKCX12), which carries slightly more risk and plays an equity long/short strategy. The fund currently has 84 long holdings compared with 36 short and returned 4.56 per cent in 2014.

Tim Cockerill, head of research at Rowan Dartington, says: "If you're trying to avoid volatility then this fund has the potential to ride through those situations quite well. The fund tries to give you a return when volatility is lower, capturing the upside and limiting the downside in the market.

"The net exposure is kept quite low and that's how risk and volatility is kept down. Typically, net exposure can go up to about 20/30 per cent. The fund runs a number of strategies and it's quite well diversified."

One of the newer funds for cautious investors is Invesco Perpetual Global Targeted Returns (GB00BJ04HL49), launched in 2013 as a competitor to the £18bn Standard Life GARs fund by three of its former team members. The fund quickly attracted attention, outperforming the IMA Targeted Absolute Return average of 4 per cent with a 9.66 return between September 2013 and 2014.

Mr Cockerill says: "Since set-up the managers have done better than the GARs team and actually achieved it with lower volatility." The fund uses more than 20 different strategies to capture returns in all market conditions. "They're looking for where they see opportunity, but always framing those trades to protect the downside," he says. A large majority of the fund's positions are currency and interest rate hedges rather than straightforward stock picks, but performance has borne out the strategy.

Equity income

Another way to lessen volatility is to choose a defensive manager with a long-term focus on quality stocks who you trust to cushion the blow if markets drop dramatically. Mr Ausden says: "These managers target quality companies with defensive characteristics; namely strong balance sheets, predictable earnings and good cash flow."

One of those managers is Peter Spiller, who manages Capital Gearing Trust (CGT) (GB0001738615). The trust is more defensively positioned today than ever before due to Mr Spiller's concerns over inflation and the level of debt in the global economy. It has a 30 per cent cash exposure, 30 per cent index-linked bond exposure and around 30 per cent exposure to investment trusts. According to TrustNet data Capital Gearing Trust has beaten the FTSE All-Share by more than 310 percentage points since 1995. The fund is focused on downside protection, returning 4.72 per cent during the 2008 crash and boasting a maximum drawdown of 15 per cent over the past 20 years. The trust may not look cheap, currently trading at a premium of 2.23 per cent, but it has been known to trade at a double-digit premium for long periods. It has a total expense ratio of 1.26 per cent.

Another quality-targeting manager is Alexander Darwall, who manages the Jupiter European Fund (GB00B4NVSH01). "When it's a cyclical market this fund leaps down the performance rating, but when investors get nervous and quality comes back up, performance goes up," says Mr Cockerill.

An equity fund that targets growth in Europe might seem a strange safe haven play and there is no guarantee that you will not lose money, but defensive fund managers can generate higher returns than absolute-return funds while offering some protection against downside volatility.

Mr Cockerill says: "You have to accept that if in six months' time the numbers are looking great then these quality funds will underperform. It's not that you won't be making money, you'll just be making less. But sometimes it's not wise to just chase those funds that are doing the best. If you're nervous, buy quality."

Mr Darwall also manages IC Top 100 fund Jupiter European Opportunities trust (JEO). The fund has performed exceptionally in the past five years, with its net asset value rising 114 per cent according to Winterflood - more than four times the return from the FTSE Europe ex-UK index. After trading on a discount for the latter half of 2014 it is now trading at a premium.

"In terms of the UK All Companies fund sector, John Wood's JO Hambro Capital Management UK Opportunities fund B GBP Acc (GB00B0LLB757) is a standout performer in down markets," says Mr Ausden. On a five-year cumulative basis it has outperformed the index, returning 74 per cent compared with 65 per cent from the FTSE All-Share. The fund's top holdings are in tobacco and consumer staples, but the managers are prepared to sell aggressively when earnings sustainability becomes questionable. The fund has a TER of 1.31 per cent, but bear in mind that a 15 per cent performance fee is payable for outperformance against the index on an annual basis.

Multi-asset funds and investment trusts

Multi-asset funds are another breed of fund that can offer protection from shocks in the long term. They often take highly conservative stances across a variety of asset classes in order to protect investors during bear markets. This will not appeal if you are keen to do your own asset allocation, but several high-profile managers have earned plaudits for their ability to defy markets.

One is Sebastian Lyon, who has a strong reputation for protecting investors against downside volatility.

"The Troy Trojan O Acc (GB00B01BP95) fund has a great track record. Mr Lyon is very conservative and always quite balanced between bonds, very stable high-yielding equities, cash and a bit of gold," says Mick Gilligan, head of research at Killik & Co.

That strategy proved hugely successful during the recession, when he managed to buck a painful trend. In 2008 the FTSE All-Share was down 30, but Mr Lyon managed to return 1.1 per cent.

"He's got a portfolio of defensive assets, many of which will probably rise when or if markets fall and he's got a few currency plays in there as well, which is partly why he made money in 2008," says Mr Ausden. "The fund doesn't try or promise to make money every year. In 2013 he lost money for the first time in 14 years because gold and inflation-linked bonds, two of his major areas, did not do well."

Mr Lyon tends to hold only very high-quality dividend-paying companies with good cash flow and predictable earnings. He keeps around 30 per cent in equities and offsets that risk with asset classes that tend to do better when markets fall. He has 12 per cent in gold and gold shares, including a gold exchange traded fund (ETF) and 19 per cent in cash, as well as over 40 per cent in global equities.

Mr Lyon also runs IC Top 100 Fund Personal Assets Trust (PNL), which is "remarkably similar" to the multi-asset fund, according to Mr Gilligan. It is currently trading at a 0.93 per cent premium.

Another celebrated multi-asset fund is CF Ruffer Total Return (GB00B80L7V87). Like an absolute-return fund, Ruffer uses a range of tactics, including investing in forward transactions and short- and long-term derivative plays in order to hedge the risk in the portfolio, as well as being exposed to a broad range of index-linked gilts and gold securities. It has been the best performing fund in the IMA Mixed Investment 20%-60% sector, with returns of 78.66 per cent since FE Alpha Managers Steve Russell and David Ballance took over in October 2006.

Mr Russell also manages Ruffer Investment Company (RICA), which was out of favour last year due to its bearish positioning. However, Ruffer has returned negative results just twice in 10 years, posting moderately positive returns during bull markets and delivering a 23.01 per cent return during the 2008 crash. The trust is trading at a premium of just 0.06 per cent.

The type of fund you should choose depends on your priorities. If preserving your capital and protecting against downside risk is key, an absolute-return fund could be best. If you are willing to take slightly more risk, choose a manager focused on strong equity income. But remember: there is no such thing as a 'safe haven' and however good your manager, there is always the chance you will lose out whether markets move up or down.

Total annual returns (%) from recommended funds vs benchmarks

Source: FE Trustnet as at 9 February 2015