Fund managers with unconstrained strategies have been quietly going about their business for a few years now. But their approach is gaining popularity as the crash has demonstrated the real benefits of agile, 'go anywhere', investing.
Fund houses often impose their own investment style and constraints on their fund managers, giving them less flexibility. Consequently, many of even the best fund managers have lost 20 per cent on their funds over the past 12 months, as - like a pair of concrete boots - the sector to which they were constrained has dragged them down.
For example, a good equity income manager may be constrained to investing a certain amount in the UK equity sector. So even if they feel uncomfortable with the UK economy, they cannot liquidate their holdings into cash.
Unconstrained funds - which do not adhere to a benchmark allocation in any particular sector or asset class - offer an alternative that has been shown to be particularly effective when managers needed to protect assets during the downturn.
An example is Martin Gray, manager of two of the funds in our portfolio (right), CF Miton Strategic and Special Situations Funds. By not being constrained to equities, Mr Gray was able to hold a lot more cash when equities began their bear run in 2007, resulting in positive returns while many other funds were diving. It also meant he was free to make some useful strategic investments in currency markets at the same time.
However, Mr Gray is keen to point out that, in his case, being unconstrained doesn't mean that the funds take a short-term approach or are regularly tinkered with. "Neither funds are active, aggressive types," he says. "They are long-term strategies driven by macro thoughts and beliefs. I want to try and make money in all markets and all cycles."
So what's the catch?
Being unconstrained doesn't mean taking huge bets on the upside, says Mr Gray. "The aim is still to protect assets. The biggest risk, therefore, is getting left behind if markets surge ahead."
Neil Avery, director at independent financial adviser (IFA) Timothy James and Partners, is also in favour of unconstrained investing, but says that it requires absolute conviction in the ability of the fund manager. He warns: "Many unconstrained funds have underdelivered in good markets and not held value on the way down. Being able to move into cash during uncertain periods sounds great, but it's incredibly difficult to get right.
"Rather than invest into generalist multi-strategy funds, we prefer to take a higher conviction approach and back the managers and individuals who we believe will really make a difference."
Mr Avery points to Jupiter's Financial Opportunities fund and Black Rock's UK Absolute Alpha fund as good examples of unconstrained funds that have used their freedom to buck the downward trend. And he is backing the M&G Optimal Income fund to use its unconstrained approach to take advantage of opportunities in the bond markets.
Mr Avery adds: "When you find a manager that you really believe in, it does help that their hands are not tied - especially in this tough environment."
UNCONSTRAINED PORTFOLIO
Iveagh Wealth Fund 35 per cent
Insynergy Odey Fund 20 per cent
CF Miton Strategic Portfolio 15 per cent
CF Miton Special Situations 15 per cent
CF Ruffer 15 per cent
About the portfolio
Neil Mumford, principal of Milestone Wealth Management, designed our unconstrained portfolio. He has undertaken extensive research of managers that have produced consistent, steady returns through a number of difficult market conditions, such as the banking crisis and the dot com crash.
Mr Mumford says: "They have a free rein on where to invest, but all have the same principles, which is to preserve capital first. They, therefore, have a contrarian approach to investing. It may mean that these managers have made unpopular calls such as reducing their equity holdings in a bull market. But they have had good reasons and this has helped them protect clients' assets. They are also not concerned about sector rankings. Their focus is on the client."
To add diversity, Mr Mumford has blended a number of contrarian unconstrained managers with slightly differing market views.
Iveagh Wealth Fund (www.iveaghwealth.com)
This fund creates an expected asset allocation that aims to produce risk adjusted returns over five to seven years. But it also allows tactical allocation, so the managers can move away from the expected portfolio to reduce risk and increase returns, according to the economic cycle. They have done this effectively and are very active as fundamentals change.
The fund invests in all major asset classes worldwide, making extensive use of exchange-traded funds. This means that it can be liquidated immediately into cash if needed.
Iveagh has a very experienced team, including the renowned John Ricciardi and Cambiz Alikhani. It is the core holding of 35 per cent in this portfolio.
InSynergy Odey Fund (www.insynergyim.com)
Crispin Odey has over 30 years' fund management experience. His track record is one of the best. He is a strategic stock picker and will invest in out-of-favour, but fundamentally strong, companies, where he shares a vision of recovery.
Mr Odey will not invest in stocks that he finds unattractive, regardless of size. He places equal emphasis on capital appreciation and protection. This fund mirrors the holdings in the Odey Opus fund that he has managed for over 18 years. This is complementary to the Iveagh fund and is the second largest holding in the portfolio at 20 per cent.
CF Miton Strategic and Special Situations Funds (www.mitonoptimal.com)
Martin Gray's cautious approach over the last 12 months has seen these funds become one of a very select bunch that have produced positive returns. Mr Gray has managed both since the launch in 1996 and his totally unconstrained approach has provided consistent returns and capital preservation through all market conditions.
The different holdings complement each other. Special Situations has a higher weighting to equities and invests in direct shareholdings and closed-ended funds such as investment trusts. The Strategic fund is more conservative and at times will hold considerably more in cash and fixed interest.
Fifteen per cent is held in each.
CF Ruffer Total Return Fund (www.ruffer.co.uk)
Capital preservation is at the heart of Ruffer's investment philosophy. A number of its funds have held up very well over the past 12 months.
The Total Return fund has produced positive returns in each year since the launch in 2000. It is number one in the cautious managed fund sector over one, three and five years to 31 June 2009.
The fund can use all asset classes without constraint. This is typified in a current holding of 8 per cent in gold and 31 per cent still in cash, while markets remain in bear territory. A 15 per cent holding in this fund is recommended.