Funds for a market bounce

I was asked the following question in October's Chatterbox and felt it warranted further analysis and discussion.

Hi Damien,
Like plenty of other people no doubt,I find myself sat on 30% cash in my portfolio. A large part of the cash has resulted from changing tack on my investment strategy since joining 80/20 and has been gathered on the back of some good returns. I am undecided when or how to get the cash back in the market but I would be interested in your opinion of which type of fund ,such as Special Situation or Recovery is best to use after any sizeable correction in equity prices, be that globally or indeed more geographically concentrated like Europe, Asia or Emerging Markets. In other words, are there funds which are renowned for better returns than average after a market downturn ?

Don't confuse value with beta

It's a very interesting question with some great nuances to it. The funds names you mention, such as Special Situation and Recovery, are exactly that - just labels. Fund names often don't have a lot of bearing on what the fund actually invests in. They are more reflective of the latest investment bandwagon that the fund house's marketing department are trying to jump upon. In terms of Special Situation and Recovery type funds these tend to follow a 'value' investment strategy. That means that they invest in companies where they believe that the share price is undervalued by the wider market. These companies may have recently underperformed their peers but the fund manager may believe that a subsequent management shakeup will transform the prospects for the firms' profitability. By investing in these unloved companies when their share price is low (i.e. when they represent good value for money) then when/if they turn a corner and their share price explodes upwards the fund manager will reap the benefits.

Now following a market crash a value strategy won't necessarily rebound, after lagging for some time, unless the cause of the fall means the new economic environment now favours the value stocks. Such a seismic shift isn't likely. Value investing is more stock specific and focuses on the company's accounts and prospects rather than macro events. So it is more likely that funds that do well in a rebound are typically those that did badly when the market crashed. The key question is how do you find these funds ahead of a crash, when you don't know what's going to sink? One way is to look at a fund's beta statistic.

What is Beta?

Beta measures a fund’s sensitivity to the general market in which it operates. The market always has a beta of 1 by definition. So if a fund also has a beta of 1 that would mean that if the market rose by 5% then so should the fund. If the fund has a beta of -1 then as the market rises so the fund falls. A well-managed index fund will have a beta of exactly 1. Funds that outperform the market when it does well but do even worse when the market is going down will have a beta above 1. So a fund that will perform well in a rebound will likely be one with a beta of more than 1. Funds' beta statistics are sometimes published on their factsheets.

Something else to consider

Now beta is calculated in reference to a fund's benchmark. So theoretically a fund could have a high or low beta but this is of little use if the fund is not being measured against a relevant benchmark. So beta shows a fund's propensity to twitch around in relation to a benchmark but it doesn't prove that the benchmark movement is what's actually causing this twitchiness. That's where another statistic, R-Squared comes in.

What is R-squared

R-Squared gives a measure of how much of a fund’s movements can be attributed to a movement in the fund’s benchmark. A high R- squared figure (0.85-1) would suggest that the fund’s performance patterns have been in line with the fund’s chosen index. A low R- squared (under 0.7) suggests the opposite. R-squared sheds light on whether the benchmark against which the fund is set against is actually relevant. A low R-squared would suggest the benchmark and therefore the Beta measure, explained above, is irrelevant. Also if a fund has a Beta less than 1 and an R-Squared close to 1 this would suggest that it is offering high risk-adjusted returns, which is a good thing. This is because the fund is capturing the returns of the general market (the R-squared bit) but is less sensitive to market movements up or down (the Beta part). For the purposes of finding funds for a rebound we want funds that have a high beta and high r-squared figures.

Now both statistics are often hard to find let alone compare. So I have compared over 2,000 funds (unit trusts) to come up with a list of funds for a rebound. Obviously well-run index tracking funds have a beta of 1 which means that if a market rebounds they will do so too.  But I've looked for those funds where the bounce should be greatest. You will notice that not every sector is included in the table below and that's because in the missing sectors there were no funds that met the criteria. Thats not to say these sectors won't contain funds that will rebound sharply, as I said those funds that tend to underperform in the crash will likely rebound the most. However the process I've followed identifies some likely suspects well before the correction and the subsequent bounce.

Of course if you really are thinking that a correction in the listed benchmarks is likely then you might want to avoid the associated fund listed beforehand.

Funds for a rebound

Name	Sector	Fund Benchmark	Beta	R squared	ISIN Code	Citicode	SEDOL Code
Standard Life Investments - European Equity Growth	Europe Excluding UK	IA Europe (ex UK) Sector	1.23	0.94	GB00B72RVY84	10FT	B72RVY8
Henderson - European Growth	Europe Excluding UK	IA Europe (ex UK) Sector	1.11	0.92	GB0030617707	N203	3061770
Architas MA - Active Dynamic	Flexible Investment	IA Flexible Investment	1.56	0.96	GB00B6ZRLF91	GD8W	B6ZRLF9
Architas MA - Active Growth	Flexible Investment	IA Flexible Investment	1.49	0.97	GB00B88MN829	GD8V	B88MN82
7IM - Adventurous	Flexible Investment	IA Flexible Sector	1.41	0.97	GB0033958009	QI86	3395800
Man GLG - Corporate Bond	Global Bonds	IA Global Bonds	1.35	0.93	GB00B0118B85	AX76	B0118B8
NFU Mutual - Global Emerging Markets	Global Emerging Markets	IA Global Emerging Mkts Sector	1.32	0.92	GB00B4Z21G10	G7AK	B4Z21G1
Jupiter - Fund of Investment Trusts	Global	FTSE All Share Equity Investment Instruments	1.22	0.96	GB0004795034	JU10	479503
JPM - Multi Manager Growth	Global	FTSE All-Share Equity Investment Instruments Ind..	1.18	0.98	GB0030869779	SA02	3086977
Margetts - Greystone Global Growth	Global	IA Global	1.1	0.95	GB00B79FLP68	I29R	B79FLP6
Architas MA - Active Moderate Income	Mixed Investment 0%-35% Shares	IA Mixed Investment 0%-35% Shares	1.3	0.96	GB00B8HWD272	GD8Y	B8HWD27
7IM - Balanced	Mixed Investment 20%-60% Shares	IA Mixed 20-60% shares	1.43	0.94	GB0033959742	QI97	3395974
7IM - Sustainable Balance	Mixed Investment 20%-60% Shares	IA Mixed 20-60% shares	1.3	0.93	GB00B1LBFZ86	Q726	B1LBFZ8
Architas MA - Active Intermediate Income	Mixed Investment 20%-60% Shares	IA Mixed 20-60% shares	1.16	0.96	GB00B7T34843	GD8T	B7T3484
7IM - Moderately Adventurous	Mixed Investment 40%-85% Shares	IA Mixed Investment 40% - 85% Shares	1.35	0.95	GB0033956516	QI91	3395651
Scottish Widows - Progressive Portfolio	Mixed Investment 40%-85% Shares	IA Mixed Investment 40%-85% Shares	1.28	0.97	GB0031611204	TS06	3161120
7IM - AAP Moderately Adventurous	Mixed Investment 40%-85% Shares	IA Mixed Investment 40% - 85% Shares	1.27	0.9	GB00B2PB2M73	BFA7	B2PB2M7
Henderson - Sterling Bond	Sterling Corporate Bond	IA £ Corporate Bond Sector	1.31	0.98	GB0007017907	PR25	701790
L&G - Fixed Interest Trust	Sterling Corporate Bond	IA £ Corporate Bond Sector	1.24	0.99	GB00B0CNHD88	LT88	B0CNHD8
L&G - Managed Monthly Income Trust	Sterling Corporate Bond	IA £ Corporate Bond Sector	1.22	0.99	GB00B0CNHQ18	LT96	B0CNHQ1
Aviva Inv - Higher Income Plus	Sterling Strategic Bond	IA Strategic Bond Sector	1.34	0.95	GB0032494576	GN70	3249457
Aviva Inv - Managed High Income	Sterling Strategic Bond	IA Strategic Bond Sector	1.26	0.95	GB0004459573	NA85	445957
Old Mutual - UK Mid Cap	UK All Companies	FTSE 250 (ex ITs) Index	1.61	0.96	GB00B1XG8963	A3I6	B1XG896
Franklin - UK Mid Cap	UK All Companies	FTSE 250 Index	1.42	0.91	GB00B7BXT545	G25T	B7BXT54
Schroder - UK Mid 250	UK All Companies	FTSE 250 ex Investment Trusts TR	1.42	0.94	GB00B76V7S22	0HD3	B76V7S2
Standard Life Investments - UK Equity High Income	UK Equity Income	IA UK Equity Income	1.39	0.89	GB00B7FTRJ84	10G4	B7FTRJ8
HC KB - Enterprise Equity Income	UK Equity Income	IA OE UK Equity Income	1.24	0.97	GB00B0V0N328	QL84	B0V0N32
Aberdeen - UK Equity Income	UK Equity Income	FTSE All Share	1.21	0.89	GB00B0XWN705	KZ83	B0XWN70
Royal London - UK Smaller Companies	UK Smaller Companies	FTSE Small Cap ex ITs	1.21	0.91	GB00B3NQHL55	LWG7	B3NQHL5
Invesco Perpetual - UK Smaller Companies	UK Smaller Companies	IA UK Smaller Companies	1.19	0.98	GB00B8N46H36	GUXX	B8N46H3
Lazard - UK Smaller Companies	UK Smaller Companies	NSCI ex-Investment Companies	1.19	0.93	GB00B7J7S065	GW3C	B7J7S06

 

 

 

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