INVESTMENT and pension funds have taken a sharp dive after a month of turmoil in the stock markets, which has seen the FTSE 100 index of leading shares plunge 634 points.

Private investors are being warned to prepare for a shock when they receive their next fund statements, as many schemes are nursing heavy losses.

Legal & General UK Alpha, which has plummeted 14% in value before charges, has been the worst-performing fund over the past month in the popular UK All Companies sector, according to figures from Bestinvest, the independent financial adviser.

Skandia Multimanager UK Assets is down 13% and F&C Special Situations has plunged 12%. All three have performed worse than the market: the FTSE All-Share index was down 8% over the same period.

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Justin Modray at Bestinvest said: “The worst-hit FTSE sectors over the last month have been mining, resources and financials. Funds with a high exposure to these sectors have generally been the worst affected by the recent falls.”

Pension funds have also been suffering. The stock-market falls have wiped about £30 billion off the assets of final-salary schemes, according to Punter Southall, a consultant. Individuals in money purchase schemes, which are predominantly invested in shares, will also have seen a fall in value.

However, some investors will be able to take comfort from the fact that their managers have limited losses by avoiding the worst-affected stocks.

Top equity performances

Marlborough UK Equity Growth is only 2% lower than a month ago while Fidelity Special Situations, managed by investment guru Anthony Bolton, is down 3%.

Both funds adopt a “value” approach, which means they focus on undervalued shares with recovery potential. As these companies are already out of favour, they tend to fall less when the markets take a tumble.

Michael Barnard is manager of Marlborough UK Equity Growth. His biggest holding is Sanderson, the technology firm whose shares reached a high of 76p in 2005 and have since plunged 39%. Over the past month, the firm’s shares have dropped 4% beating the 8% fall in the market. Barnard said: “Many of the stocks in my portfolio don’t move in line with the index.

“I have also benefited from the defensive stance of putting 13% of my portfolio in cash.”

Ways to cut your risk

Investors who are worried about their fund’s performance are being urged not to make any snap decisions based on a single month’s performance. Most commentators believe that the storm will blow over as the stock market is fundamentally sound and shares look good value.

However, few are willing to bet how long this will take. If you are worried about a longer-term downturn now might be a good time to take profits from some riskier areas that have done well in the past few years, such as medium-sized companies, and put the money into sectors such as larger firms that pay healthy dividends.

Strong firms that generate plenty of cash and pay good dividends have a better chance of withstanding further turbulence.

A good way to access them is via an equity-income fund, and advisers suggest Invesco Perpetual Income or Newton Higher Income. The portfolio of both funds is dominated by large defensive companies such as British American Tobacco and BP. Even if the markets recover quickly many advisers believe income funds make good core holdings.

Brian Dennehy at Dennehy Weller, an adviser, said: “Many analysts believe stock market returns in the next 10 years could be 8% a year at most. If so, a fund investing in shares yielding 4% generates a good chunk of that total return before any capital growth comes through.”

Another way to cut risk is to drip-feed money into the market on a monthly basis. This works when markets are volatile because of pound-cost averaging. If you invest a set amount on a regular basis, you buy fewer shares when their price is high, but more when the price falls.

For example, if you made regular contributions of £100 a month and shares were at 100p one month, you would buy 100 shares before costs were taken into account. But if the price dropped to 50p the following month, your savings plan would buy 200 shares before costs. So you’d get more shares for your money when the prices were low.

You should also ensure you have a balanced portfolio. Modray suggests that a medium-risk investor should have about 70% of his or her portfolio invested in equities, 15% in commercial property and commodities and 15% in corporate bonds.

Bond funds

Bond funds have held up relatively well over the past month. The worst performer, Margetts Greystone Fixed Interest, is down just 0.5% before charges. The best performer was Aber-deen Long Bond, up 5%.

Speculation that rates could have peaked in Britain and that the Fed rate may even start to fall in America is encouraging some fund managers to start backing bonds again. Bonds tend to perform better when rates fall because they pay a fixed return, which makes them more attractive to investors.

If you don’t already own any bonds and want to include them in a balanced portfolio, it could be a time to buy. Dennehy recommends the Artemis and Hender-son Strategic Bond funds and Newton International Bond.

However, many analysts are still cautious about bond schemes, which haven’t performed well over the past year: UK bonds are up only 1% and international bonds have risen just 3%, according to Clerical Medical. Cash, which is paying 6%, looks a better option for the cautious.

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