A crop of durable diversifiers

With government bonds struggling alongside equities, solid diversifiers have started to look like gold dust in recent months. Not all defensive assets have lived up to their reputation as the storm clouds have gathered. Take the wealth preservation trusts, a group which includes both the outperforming Ruffer Investment Company (RICA) and RIT Capital Partners (RCP) whose shares have fallen harder than even the MSCI World index recently (see Which defensive funds are working? IC, 04.03.22). Or, as the IC’s Alex Hamer pointed out, the relatively middling performance of physical gold so far this year is another example (Gold: Stuck in the middle with Au, IC, 20.05.22).

That’s arguably a reminder to diversify across different safe-haven assets, mindful that their idiosyncrasies can produce markedly different bouts of performance when a crisis comes. But it’s also worth considering what has worked in the most recent bout of volatility and whether the most recent winners have done quite so well in previous sell-offs. To assess this, we have looked at recent strong performers, gauging how they fared in the pandemic sell-off in early 2020 and the sell-off in the closing quarter of 2018.

Also remember that markets can crash for different reasons, meaning that no one diversifier is a reliable bet. In the case of government bonds, they could well recover as recession worries gather or prove defensive again in other future scenarios.

An analysis of performance from the past six months highlights a variety of resilient sectors from property to renewable energy, and a handful of absolute return funds that are also mitigating downside.

Absolution

We pointed out the shortcomings of absolute return funds in 2020, and that many funds with a remit to deliver positive returns in different conditions have lagged when markets rise but done little to defend capital in a sell-off (Absolute return funds: useful in a sell-off? IC, 13.03.20). Funds with macro or long/short strategies can be especially volatile because their managers can take big bets on certain developments materialising, from a move in interest rates to currency shifts.

But a few absolute return funds have also delivered over the past six months. As the table shows, VT Argonaut Absolute Return (GB00B7FT1K78) has navigated recent market gyrations extremely well and performed strongly earlier on in the pandemic. The fund has been positioned as a play on the move away from growth stocks persisting, with its recent literature stating: "After more than a decade long boom in long duration equities and bonds, the fund offers investors a unique and valuable hedge on the risk of a 1970s redux."

At the end of April, the fund's factsheet noted that its managers had made "significant money" from short positions that month, after US online car sale platform Carvana's (US:CVNA) share price plummeted, electric vehicle outfit Rivian Automotive (RIVN) continued to struggle and German property vehicle Adler's (DE:ADJX) shares tumbled following a damning special audit by KPMG.

In terms of long positions, in April the fund's managers upped exposure to reopening oppportunities in travel and leisure as a play on "cabin fever" among consumers and travel companies having unusually high pricing power. VT Argonaut Absolute Return benefited from long positions in German potash miner K+S (DE:SDF), Brazilian agricultural developer SLC Agricola (BRAZ:SLCE3) and Belgian oil tanker company Euronav (US:EURN) over the month.

The table shows that the fund has fared better than the MSCI World index during other recent sell-offs. However, VT Argonaut Absolute Return's performance at other times illustrates how binary the outcomes can be for some racier absolute return funds – it lost around 25 per cent in 2016 and has lagged buoyant markets at times.

Other absolute return funds highlighted in the table are also taking punchy bets. LF Brook Absolute Return (GB00B55NGS86) had some fairly chunky long equity positions at the end of April, with 9.3 per cent of its assets in trading platform Plus500 (PLUS), 8.7 per cent in Frasers (FRAS) and 8.4 per cent in Jet2 (JET2). Energy plays such as Glencore (GLEN) and Shell (SHEL) were also in the fund’s top 10 holdings.

Most of the absolute return funds in the table have fared better than the global equity market in a sell-off, although this has sometimes involved taking lesser losses. But not all of these funds are readily available to private investors.

For another 'macro' play, also remember BH Macro's (BHMG) impressive record, which we profiled in April (IC, 08.04.22).

Sector specifics

As in the equity market, worries about inflation and rising rates, among other things, have pushed investors into a narrow group of sectors. Property has upheld its status as a good inflation play, with shares in UK commercial property trusts such as BMO Commercial Property Trust (BCPT) rising in the past six months. Renewable energy infrastructure trusts have also fared well over the period, thanks to a combination of factors, from rising power prices to the Ukrainian conflict resulting in a greater focus on the energy transition. See big gains from the likes of Foresight Solar Fund (FSFL), Ecofin US Renewables Infrastructure Trust (RNEW) and Gresham House Energy Storage Fund (GRID), among others.

Idiosyncratic problems, once again, may come into play. Some of the renewables trusts sold off when it emerged that the chancellor was thinking about levying an energy windfall tax, and Bluefield Solar Income Fund's (BSIF) board extended the timetable of a planned equity placing in response. 

Bad news has arrived for some winning property plays. Logistics assets investors such as Tritax Big Box REIT (BBOX) sold off in recent weeks after a weak update from Amazon.com (US:AMZN), a major user of logistics warehouses.

And market volatility can knock the share prices of even the most defensively positioned investment trusts, although this can sometimes present a buying opportunity. Think, for example, of premiums to net asset value receding on infrastructure trusts in the early days of the pandemic.

In recent months, trusts focused on more niche asset classes have offered a reprieve. Round Hill Music Royalty Fund (RHM) delivered a share price total return of 6.6 per cent over the six months to 24 May. While this asset class is gaining fans, some have questioned how it will fare in a full market cycle, how valuations will be affected by rising interest rates, and how vulnerable music streaming businesses are as consumers face rising costs and the threat of recession.