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 |
