How to negotiatethe ravages ofa falling equitymarket

Investors hoping that fund managers in the three IMA managed sectors would be able to protect them from the ravages of a falling equity market have been severely disappointed this year. Short-term equity results are weak and the outlook poor. Longer term, weak bond markets have pushed down overall returns for the most cautious funds.

According to the latest IMA statistics, July was not a happy month in the Active, Balanced and Cautious Managed sectors that account for £30bn of collective investments, some 7.2% of the industry total. Retail sales in the biggest sector, Cautious Managed, were relatively strong at £24.5m but the other two sectors experienced outflows of £17m as investors gave up on widespread losses.

Iain Tait, an executive director at London & Capital, is not surprised by their dissatisfaction. He said: "As a wealth manager, we have had net inflows in bond and Sipp structures, but people are more unsure than ever where to invest. They can get 7% on the internet on deposit and that is what they will do. We cannot rush them into falling markets."

Asset allocations

He believes many investors have been shocked to find the true asset allocations of their managed funds. He added: "Balanced Managed has always seemed such an unusual description to use with inexperienced investors when the fund can be over three quarters invested in one single and the most volatile asset class - equities."

From an asset allocation point of view, the IMA Balanced Managed sector is neither balanced nor generally well managed given the investment requirements placed on managers, thinks Tait.

Balanced Managed fund managers can hold up 85% of their portfolios in equities and must --hold a minimum of 10% in international equities. Given the lack of diversification in the sector, Tait has no single fund recommendation in current markets. However, he said Fidelity, Newton, Thames River, Jupiter and Threadneedle have strengths, given the right conditions.

The exception may be the small but growing number of funds using Ucits III powers, although they may not remain in the sector for much longer. Tait likes BlackRock Absolute Alpha, run by Mark Lyttleton, a fund that recently defected to the new Absolute Return sector, which would have been Balanced Managed's third-best performer over the year to end August with a 9.82% gain.

Positive territory

The Balanced Managed sector itself was down 5.34% over the same period. Just 13 of the 133 funds with one-year figures were in positive territory over that time. The poorest results were posted by Marlborough CFS Balanced Managed fund, down 25.55% on the year, due in part to the dominant position held by UK equities in its portfolio.

At the other end of the spectrum, Ruffer European manager Timothy Youngman is cutting back UK equity exposure, now down to just 3%, a smaller proportion of the portfolio than is held in just one fixed interest bond, a Norwegian gilt maturing in 2011 and paying 6%.

Long-only continental equities make up 30% of Ruffer European but are by no means a sure bet. Youngman's 1.9% put on the DJ Stoxx 200 of larger European companies is also a top 10 holding in the fund. For the time being, over 58% of the fund remains in cash.

Meera Patel, senior fund analyst at Hargreaves Lansdown, picked a fund further down the short-term table as her favourite from the Balanced Managed sector. She plumps for Neptune Balanced, run by Robin Geffen, for its longer-term returns as well as its current cash holdings.

She said: "Robin Geffen has had this fund well placed to weather the market turbulence. At 37%, the fund's larger than normal exposure to cash has proven helpful and Geffen intends to put this to good use on days when the markets are particularly weak."

Geffen is maintaining his negative stance on banks, insurers and property in the UK and expects further bad news. His contrarian pharmaceuticals position has delivered strong recent returns after a period of negative newsflow.

In the last 12 months, the Neptune fund lost 0.15%, a small enough fall to maintain a top quartile position. It is fourth over three years and generated 87.41% over five years, earning it third place.

Cautious Managed funds must maintain at least 30% holdings in cash and fixed interest, and equities are limited to a maximum 60%. That higher low-risk content has bolstered one-year returns for the sector, as has the number of funds with multi-asset strategies, making them among the healthiest of the managed group.

Catch-22

But for traditional funds with just long-only bonds and equities to play with, managers are 'doomed if they do, doomed if they don't', believes Tait. Not surprisingly, therefore, three-year returns look weak in comparison as slack bond markets hit over the longer term.

Average losses in the sector were 4.29% over the year, lower than those recorded by Balanced and Active funds. Three-year returns average just 7.55%, battered by bond market conditions, and represent a loss in real terms for investors once inflation is taken into account.

Anti-sterling returns

Ruffer again tops the charts with an 11.33% one-year return from the Total Return fund run by David Ballance and Steve Russell. The fund offers a 'slice of Ruffer' reflecting thinking across the investment firm. Having gone cautious too early and suffering a dull patch late in 2006 and the first half of 2007, Ballance said the fund has bounced back thanks to an anti-sterling stance.

He said: "Overall, we are 35% to 40% equity or greed assets, with the remainder in fixed interest, cash and gold. The overwhelming contribution has been made by assets outside the UK, particularly the 20% held in Swiss bonds and 11% holding in domestic cashflow Japanese equities."

Ballance remains worried about the world outlook but recently bought into mortgage-backed securities with US Reit Annaly on the expectation that Fannie Mae and Freddie Mac will be nationalised, resulting in US-style Northern Rock government guarantees on underlying assets.

Arch Cru's Income and Investment Portfolio make up the sector's number two and three best performers over one year and other Arch cru funds rate reasonably in other sectors. But Patel warned that investors need to be particularly selective and look carefully at asset allocations and strategies.

She added: "In these sectors, you will notice that the Arch Cru funds top the tables when it comes to performance. These funds invest in private equity and structured investment among other investment vehicles. While I cannot deny that performance has been good, these more esoteric assets lack transparency."

In Cautious Managed, Patel chose a more conventional portfolio. She said: "One of our favourite picks is the Invesco Perpetual Distribution fund. It goes without saying the fund benefits from the skills of Neil Woodford on the equity side, and Paul Read and Paul Causer on the bond side, so it is backed up by a superb team."

Invesco Perpetual Distribution fell 1.84% over the year but has recovered in the very short term. Over three years, returns are 13.94%.

Targets

Patel also likes the JPMorgan Cautious Total Return fund, although it is not being currently recommended. Managers Neill Nuttall, Talib Sheikh and Tim Harris have a target of cash plus 3% to hit and managed only 3.34% in total over the last year with their portfolio currently 58.9% in cash and money markets. 51% of the fund's assets are also in short positions.

Actively Managed should theoretically be the most able to adjust to difficult market conditions with no maximum and minimum investment constraints. In fact, at -5.82%, the sector is down slightly more than Balanced Managed peer group, with just 16 of the 122 funds posting gains. Iimia Accelerated and New Star Global Strategic Capital both lost more than 20% on the year.

Internal and private client funds dominate the best performance. Three Newton non-retail funds are up under 1% and a further four make it into the top 10 with returns from 2.26% up to 9.41%.

Sarasin Equisar leads the sector, up 9.78%, closely followed by Kleinwort Ramogan up 9.77%.

Global themes

Nick Clay, manager of Newton Managed (+0.69%), said the group's global themes approach is working well. He said: "The three key themes are debt and credit, energy supply and earth matters. We are underweight bonds as inflation is coming in higher than people expected and looking at higher yields in the developing world. The risk weighting is about to change with Asian nations having net savings and their governments net surpluses."

Again, Patel ignored the best performing short-term players and opted for Skandia Global Best Ideas, down 7.55% on the year and below the sector average.

Ryan Hughes, fund manager at Skandia, said that while the fund is down on the year, certain themes have played well. Among them was an overweight energy play sold down at the right time as stock prices fell. Underweight financials has been a good bet although the fund will have missed out on the recent rally.

Geographically, Canadian mining and Indian stocks have added and an underweight position in Russia has protected the fund from further damage in recent months.

Hughes added: "Despite conditions, the managers are very positive. They are taking 12-month-plus views, seeing cheap valuations and a great opportunity to pick up stocks. Investors need to be patient as, in volatile conditions, even great companies can experience sharp price changes."

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