INVESTORS should brace themselves for a 10% fall in the UK stock market next
year, Goldman Sachs, the investment bank, warned last week.
And fellow investment bank Morgan Stanley fears things could be even worse,
with a one-in-three chance that the FTSE 100 could plunge more than 1,000
points to 5,350 – 18% lower than Friday’s close of 6,555 – as the bull
market finally ends.
The risk of a recession has heightened, with some economists warning there is
now more than a 50% chance that growth will turn negative in the US, and
some of Britain’s best-known investors even talking of a recession here.
Neil Woodford of Invesco Perpetual, one of the managers tipped below, said
last week: “There’s a reasonably strong chance that we’ll see the housing
market, which has been a prop for the UK consumer – and by implication the
economy – for so long, suffer. Undoubtedly, as we have seen in the US, when
the housing market corrects it can have a violent effect on the economy.
“I don’t want to be a purveyor of doom, but there is every possibility the
housing market is correcting and will deliver a shock to consumer confidence
and spending. In this situation it’s likely we’ll flirt with recession.”
Even if a full-blown economic slump is avoided, company profits and share
prices are expected to be hit.
Graham Secker of Morgan Stanley said: “Be defensive – capital preservation
will be key next year. We believe that any cash you can accumulate today is
likely to become more, not less, valuable in the months ahead. Within equity
portfolios we would encourage investors to go defensive.”
One of the stock market’s leading historians also warned last week that a
bear-market signal had flashed red. David Schwartz said: “History teaches
that a sudden flurry of big daily price swings (up as well as down) in
excess of 1% is consistently linked to bear markets.
“We’re experiencing the ninth spurt of abnormally high inter-day volatility in
modern times. No guarantees, of course, but if history is any guide, the
bear market of 2007 is probably now under way or shortly will be.”
Financial advisers said investors should check their portfolios are not overly
exposed to equities. Darius McDermott at Chelsea Financial Services said:
“Over the past four years almost all funds have made money – some have made
a lot more than others. But the volatility we have seen in recent months is
going to continue into next year and it will become much harder to make
positive returns. Investors therefore need to look for managers who have
proved that they can make money, even if the markets fall.”
We asked Citywire, a financial website, to identify the funds that are likely
to weather the downturn well. They are all run by managers who beat their
peers during the prolonged bear market of 2000-3, and who have continued
consistently to outperform.
Blackrock Absolute Alpha
Run by Mark Lyttleton, Blackrock’s Absolute Alpha fund is one of the few
schemes taking advantage of a change to investment rules that took effect in
2004. This enabled managers to use derivatives – financial instruments that
can make money in falling markets.
Lyttleton uses a strategy known as “going short”. If he thinks a company’s
share price is going to crash, Lyttleton can borrow shares in the company,
sell them at the current high price and then buy them back for less when
they fall. He has to give the shares back to the real owner, but if they
have fallen in value he can pocket the difference.
Such funds have not yet been properly tested given that the FTSE All-Share
index has risen 49% since 2004.
However, Lyttleton has a good track record on the other funds he manages. He
has been running Merrill Lynch UK since 1999 and the UK Dynamic fund since
2003. Since 1999 he has beaten his index benchmark by an average of 0.28% a
month, according to Bestinvest, an independent adviser. During the
volatility of the past six months the Absolute Alpha fund is up 4.1%, while
the All-Share is down 1.2%.
Lyttleton said: “The fund has produced positive returns in July, August,
September, October and November – I doubt many other funds have managed
that.”
Much of his recent strong performance has come from shorting retailers and
banks.
Invesco Perpetual Distribution
Distribution funds invest in equities and bonds, and Invesco Perpetual’s fund
is handled by some of the leading managers in each sector. Neil Woodford,
who also runs the Income and High Income funds, handles the equity element
and was one of the most successful managers during the last bear market.
During 2000-3, when the FTSE All-Share fell 44%, Woodford’s funds rose 7.2%
and 5.2% respectively. And during the recent volatility, Woodford has
benefited from having no exposure to the banking sector. He has been backing
defensive stocks such as British American Tobacco, Glaxo Smith Kline and BP,
which should be a safe haven in a market downturn.
The bond element is managed by two of the most esteemed managers in the
sector, Paul Causer and Paul Reed, who are upbeat about the prospects for
bonds.
They tend to rise when equities are choppy because they are seen as a safe
haven. They also tend to be a good investment when interest rates fall
because they pay a fixed income, which becomes more attractive as interest
rates drop.
Invesco Perpetual Distribution has managed to produce a positive return of
0.4% over the past six months, according to Citywire, compared with a fall
of nearly 5% in the average UK equity fund. The Invesco Perpetual
Distribution fund has risen 40% since it was launched in 2004.
Merrill Lynch Gold & General
The gold price has risen 25% this year and is now $792.50 (£391) an ounce. It
hit a 27-year high of $846 an ounce last month and some analysts believe it
may yet surpass 1980’s $850 an ounce. John Read at UBS, an investment bank,
said it could even go beyond the $1,000 an ounce mark.
Gold has long been viewed by investors as a safe haven in times of
stock-market and economic uncertainty. Demand for gold jewellery is also
strong, particularly in Asia and the Middle East where there is a burgeoning
middle class. But despite strong demand for the precious metal, supply is
tight and this should also help to underpin the price.
Merrill Lynch’s Gold & General fund, run by Graham Birch, has soared
over the past five years – investors have seen the value of their
investments rise by 152%. In October alone it rose 8.1% as gold benefited
from the weak dollar, rising oil prices and geopolitical tensions in the
Middle East.
Old Mutual Corporate Bond
While equity investors have been enjoying a great time over the past few
years, those with money in bond funds have seen little in the way of growth.
However, the tide for bonds could now be turning, and Citywire identified
Stephen Snowden, who runs Old Mutual Corporate Bond, as being a manager who
should do well if the stock markets fall.
Snowden joined Old Mutual in 2004, having previously managed Aegon Corporate
Bond. Between 2000 and 2003 Snowden returned 24%, compared with 19% for his
benchmark index, and over the past three years the Old Mutual fund has risen
16.1%, compared with 12.8% for the index.
READY FOR THE UPS AND DOWNS
ALISTAIR ELLIOTT, a budding novelist from Brighton, should receive some
protection from his investment in the Norwich Union Sustainable Futures
Corporate Bond fund if the stock market nosedives.
Elliott, 49, has not been impressed by the fund’s performance so far as it has
lagged his racier stock-market investments.
Over the four years that he has been invested it has risen 12% while the FTSE
100 is up 48%. However, he believes it could prove valuable if the worst
stock-market forecasts prove correct.
The fund invests in the bonds of companies that are deemed to be encouraging
good ethical or environmental practices.
Elliott, pictured with his 10-year-old daughter, Savannah, said: ‘I believe in
investing for the long term so am prepared to ride out the ups and downs of
the stock market. But over the next few years a bond fund may prove to be a
good idea.’
