Alternative investments: how should you plan for a bear market?
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We can safely say the past few weeks have been stressful for investors. We’re now just a smidgen away from a bear market, with the S&P 500 benchmark US index down about 18 per cent between January 3 and May 12 (most observers regard a bear market as starting at a loss of 20 per cent).
But this number hides massive variation. On my blog I’ve been crunching the dispersion of returns over the year to date and the numbers are hugely revealing. Of the stocks in the S&P 500, 129 have recorded gains while 175 stocks have already recorded losses of more than 20 per cent.
In the broad Nasdaq Composite index of nearly 5,000 stocks, including minnows as well as leviathans, just under 20 per cent of stocks — 948 to be precise — have recorded losses of more than 50 per cent.
I take no pleasure in saying much of this carnage was grimly predictable — valuations were crazy and macroeconomic conditions were and are deteriorating at frightening speed.
But UK investors could have protected themselves, especially if they used a select band of listed funds, be they investment trusts or index tracking exchange traded funds. I’ve also been crunching through performance numbers for these funds over the same period to see how more adventurous types might have fared.
Let’s start with investment trusts. Mixed in with the predictable there are also some real surprises. You’d have done very well if you’d invested in almost any resource-based investment trust or any fund oriented towards energy-rich countries such as Brazil or Qatar. But I’d be cautious about these funds sustaining those returns if markets go into full bear mode. If we do slip into a global recession the elevated commodity prices won’t stay high for very long.
There were also, predictably, positive gains from investing in renewable energy funds. Foresight Solar, JLEN Environmental Assets, Greencoat UK Wind and ThomasLloyd Energy Impact have all had a great start to the year, notching up gains of 10 per cent or more over the period, helped along by resurgent power prices.
One could argue that these funds will continue to benefit from the structural shift to renewables but wholesale power prices do seem toppy to me. The handful of energy storage funds — GRID, Harmony and Gore Street — have also posted impressive returns and have undoubtedly benefited from those wholesale energy prices. But there’s a long-term shift in favour of energy storage working its way through the system, not least fuelled by that surge in renewable power — which is only going to increase even if wholesale prices decline.
Among the other winners are defensive multi-asset funds. Ruffer Investment Company, one of my long-term favourites, is out on top followed by Capital Gearing and Personal Assets. But the standout winner has been listed hedge fund BH Macro, whose share price has shot ahead, helped by an increasing premium.
In the more surprising category are a few options that might be worth sticking with over the next unpredictable months. A small group of equity income funds focused on boring equities with generous dividends have done very well, led by Murray International and then the City of London Trust, Temple Bar and Henderson International income. This equity income focus has underperformed over the past few years but could be about to come into its own in these turbulent times.
Infrastructure funds such as HICL and INPP, which have been as dull as ditchwater, might now represent a good alternative home for cash. I would also highlight a handful of alternative asset funds, many of which I have championed and which have performed well since the start of the year. Biopharma Credit in the speciality lending space has been a dull but solid stock, as has Digital 9 in digital infrastructure.
Special mention must go to the complex beast that is Tetragon, which includes hedge funds and big stakes in a host of asset managers. Over the past few years its share price has been going nowhere, but it seems to have come into its own in recent months, and is up nearly 17 per cent over the year to date.
Among exchange traded funds, anything resource-related has also shot ahead. I’d highlight the small number of energy infrastructure ETFs, such as Invesco’s Morningstar US Energy Infrastructure fund (MLPQ). These invest in everything from storage tanks to pipelines. Energy prices might come down, but I don’t see demand for these income-oriented infrastructure assets tailing off very fast.
On the energy theme, two index funds from Wisdom Tree and SparkChange that track European carbon prices via the emissions trading scheme have had a great run, although they did take a kicking immediately after the Russian invasion of Ukraine. Investors’ fears that green transition policies might be junked have not yet been realised and prices rebounded. Keep watching this space closely.
If you’re looking for a defensive place to stash any cash from profit-taking, ultra short duration dollar-based bond funds have been a sensible place to start — and might stay that way. The relatively plentiful supply of ETFs in this space have benefited from a strong dollar even though yields are low (but going up).
As I predicted, foreign exchange tracker funds that are long the dollar and short sterling — Wisdom Tree has one with the ticker GBUS — have had a “sterling” bear market. I think there might even be further to go before market volatility dies down.
Last but by no means least are ETFs focused on dividends — that equity income theme again — which have also done well. S&P’s long-established Dividend Aristocrats range is a great place to start but I’d also highlight Lyxor’s Global Quality Income strategy developed by SG as another great defensive spot in an uncertain market.
So, if — and that’s a big if — markets remain unstable or become even more bearish, what would I do? I’d be tempted to evolve the classic approach of holding a core of lower-risk investments alongside thematic satellite assets, but with a more defensive flavour. In the core you might have Ruffer Investment Company and BH Macro, alongside something unexciting — say, an equity income fund such as Murray International, City of London or Lyxor SG Quality Income.
The satellite investments would be built around robust themes and sectors. These might include battery storage funds such as Gresham House Energy Storage, Gore Street and Harmony Energy Storage, digital infrastructure funds such as Digital 9, and specialist lenders such as Biopharma Credit. If you’re feeling a little more exotic, think about adding SparkChange’s Carbon ETF and the Wisdom Tree Short Pound Long Dollar tracker.
The point is to balance the boring stuff with funds that are still growing — steadily driven by long-term drivers such as decarbonisation and digital infrastructure that even the gloomiest of bears might acknowledge.
David Stevenson is an active private investor. Email: firstname.lastname@example.org. Twitter: @advinvestor. He has holdings in Gresham House Energy Storage, where he is a non-executive director; BH Macro; Digital 9; and the Wisdom Tree Short £ Long $ ETF