How fund managers prepare portfolios for a downturn

Few funds made it through 2022 unscathed, and even those with an explicitly defensive profile took a hit. A combination of problems, including a painful government bond sell-off, ultimately took its toll on most of the so-called wealth preservation investment trusts, although most of them fared better than equity markets. Personal Assets Trust's (PNL) and Capital Gearing Trust's (CGT) share price total returns fell around 4 per cent in 2022, while RIT Capital Partners' (RCP) share price total return was down by more than a fifth. However, their more cautious peer, Ruffer Investment Company (RICA), made a decent share price total return of around 7 per cent.

These four names are well known for running some equity exposure but also using a variety of assets – from classic safe havens such as bonds and gold to more esoteric holdings – as a way of protecting investors from the worst pain of stock market falls. So with challenges persisting in 2023 even as equity markets show some signs of life, it is worth looking at how these trusts are positioned now.

Their thoughts on markets

The managers of the wealth preservation trusts tend to fear moments of market exuberance, so it is little surprise that they harbour concerns about this year's market rally. 

Ruffer's investment team recently warned that taking a cautious view on markets had been a “painful experience” in the first five months of this year, with the trust giving back many of the gains it made in 2022. However, they warn that current market conditions look ominous.

“With a 5.25 per cent risk-free return available in US money market funds, cash has only been such an attractive alternative to equities twice this century: in 2000 during the tech bubble, and in 2007, just before the financial crisis," the team noted at the end of May. "Neither period ended well for investors and we fear a similar outcome could be lying in wait for markets now." The managers also worry that policymakers have limited scope for action in the event of a crisis: "With inflation more persistent than promised, central bankers would have to choose between monetary stability (fighting inflation) or financial stability (supporting markets). Add into this worrying picture a technology, media and telecoms-like boom concentrated in just a few US stocks. All of this points to an emphasis on protection rather than growth."

Personal Assets Trust's investment team has also pointed to the narrow market rally in the US as a red flag. “As we head into an economic downturn investors coalesce around an ever-smaller number of successful growth stocks,” they said. “In the UK in 1989 it was Glaxo and Guinness – fund managers not holding these two stocks underperformed. In 2000, after the dotcom bubble burst, investors huddled around the safety of Cisco, IBM, Lucent and Intel (Microsoft is the only successful survivor of that era).”

Capital Gearing Trust's investment team, meanwhile, noted in May that concerns about inflation and recession risks had prompted them to reduce exposure to risk assets and “take shelter in Treasury bills”. And RIT Capital's managers warned in the trust’s annual report for 2022 that market conditions could be challenging, but added that such difficulties could throw up good investment opportunities for the longer term.

Where they are invested

These generally bearish sentiments are matched by these trusts' recent asset allocations. They all run some equity exposure alongside more defensive holdings, but many of these weightings are fairly low. For example, Capital Gearing Trust had a 28 per cent equity exposure at the end of May, RIT Capital Partners had 26 per cent, Personal Assets Trust had 22 per cent and Ruffer Investment Company just 15.3 per cent.

Exposures to bonds, by contrast, are sizeable. Capital Gearing Trust had a 70 per cent allocation to bonds, which includes some corporate debt and preference shares but also a substantial investment in index-linked government bonds. These tend to perform well as inflation expectations grow, but can be vulnerable to the interest rate rises that often follow bouts of rising prices, in part because they tend to have higher levels of duration (interest rate sensitivity).

Personal Assets had a 65 per cent allocation to bonds, which included 35 per cent in index-linked US Treasuries and 30 per cent in short-dated government bonds.

Personal Assets's lower exposure to inflation-linked debt should make it slightly less vulnerable to rate rises, relatively speaking. But it would then see less upside if and when rates stabilise and fall. Ruffer, meanwhile had, 46.4 per cent in fixed income, 29.5 per cent of which was in short-dated bonds and 16.9 per cent of which was in different kinds index-linked bonds.

Ruffer had 15.7 per cent in illiquid strategies and options, the latter effectively serving as insurance against market falls, and 7.1 per cent in cash. These three trusts also had some exposure to gold and gold-related equities, and Personal Assets led in this respect with an 11 per cent allocation at the end of May.

RIT Capital is more of an unusual beast in that it tends to have more esoteric investments, including private assets accessed directly and via funds, and absolute return portfolios. That makes it hard to compare with the others and sometimes harder to understand, although the trust has delivered the goods over long periods.

Which one suits you?

Specialists have different views on the options available and the trusts can serve different purposes. Some investors who need a balanced portfolio with a mixture of growth and defence might view them as a one-stop-shop or at least a core holding. And some adventurous investors might even hold such trusts in place of cash. But the four trusts vary notably.

Mick Gilligan, head of managed portfolios at Killik & Co, views Ruffer as the least volatile of the four thanks to its cash position, heavy exposure to short-dated bonds and use of options. He puts Personal Assets in second place due to its use of short-dated bonds and equity exposure via "high quality equities that tend to exhibit low volatility". This trust's largest equity holdings at the end of May included Unilever (ULVR), Nestle (CH:NESN), Visa (US:V), Diageo (DGE) and Alphabet (US:GOOGL). Gilligan thinks that Capital Gearing has the greatest level of positive inflation linkage via index-linked bonds and some infrastructure.

And he believes that RIT Capital Partners is the raciest option due to its combined public and private equity exposure of nearly 70 per cent of its assets. So you may favour Ruffer as an especially cautious option and RIT as a way to capture market gains. James Carthew, head of investment company research at QuotedData, adds that RIT Capital Partners has fared best over longer periods and says: "If we are looking five or 10 years out from here, I’d expect it to be top of the pile again."