Global stock markets finished 2016 in a buoyant mood with the FTSE and the Dow starting the new year at or close to all-time highs. In bull markets it is easy to ignore the potential pitfalls of investing, but the list of macro events that could bring it all crashing down seems to be longer than ever.

In Europe there is a real risk that Brexit could help to inspire a far-right win for Marine Le Pen in the French election in the spring, which could result in the country leaving the euro. There is also a lot of unhappiness in Germany about Angela Merkel’s refugee policy that could see her lose the chancellorship in the autumn.

Across the pond it is not yet clear whether president Trump can deliver sufficient tax cuts and infrastructure spending to stimulate the US economy, or whether he will go ahead with his protectionist policies and undermine world trade.

There is also a risk that China’s debt problems could get out of hand, or that Russian president Vladimir Putin takes advantage of a weakened NATO and the West suffers a serious terrorist attack.

Each of these have the potential to become a black swan event with the power to trigger a stock market crash, thus creating a real dilemma for bearish investors. If they keep their money in cash and none of these things happen the market will probably climb a wall of worry, but if they invest in a traditional portfolio they could get their fingers badly burned. So what should the nervous investor do?

GOLDEN INVESTMENT

Richard Scott, senior fund manager at Hawksmoor, recommends that an ultra-bearish individual who is worried about the downside risk should have exposure to gold.

‘We have exposure to the CF Ruffer Gold Fund (GB0033628156) and BlackRock Gold & General (GB0005852396) to guard against some of the bearish risks that threaten to undermine the value of bonds and equities.’

He says that among the most serious threats is a disorderly unwind to the problem of rising debt levels. If there was a spike in the rate of inflation or widespread defaults then gold would probably be one of the few assets to perform strongly. It would also be likely to provide protection against negative geo-political shocks or a break-up of the eurozone.

‘We believe both the Ruffer and the BlackRock funds provide a well-managed exposure to mainly gold mining shares, with the weekly dealing Ruffer fund having a higher exposure to mid and small cap gold miners.’

Another option would be to invest in a gold ETF such as ETFS Physical Gold (PHAU) or Source Physical Gold P-ETC (SGLD). These are designed to track the price of gold and have ongoing charges of 0.39% and 0.29% respectively.

Physically-backed silver ETFs should also offer similar protection with examples including ETFS Physical Silver (PHAG) and iShares Physical Silver (SSLN).

DEFENSIVE INVESTMENT TRUSTS to consider

Emma Bird, a research analyst in the Winterflood investment trust team, recommends that ultra-bearish investors should consider Capital Gearing Trust (CGT), managed by Peter Spiller of CG Asset Management, and Personal Assets (PNL) which is managed by Sebastian Lyon of Troy Asset Management.

‘Capital Gearing seeks to achieve absolute returns through active asset allocation across equities, bonds and commodities. Equity investments are made in quoted closed-ended investment trusts and other collective investment vehicles. The aim is to preserve capital over the short run and generate strong risk-adjusted returns over the long-run.’

She says the fund has an impressive record of delivering strong absolute returns with considerably lower volatility than equity markets.

‘While the 60% allocation to bonds will mean the fund is likely to lag strong equity market rallies, we believe it is an attractive vehicle for investors looking for low volatility long-term capital growth. It should also provide protection on the downside in the event of a market decline.’

Her second recommendation, Personal Assets, has an absolute return mandate with an objective to ‘protect and increase (in that order) the value of shareholders’ funds over the long-term’.

‘Troy Asset Management is focused on strategic asset allocation and stock selection, with the latter concentrated on high quality companies available at the right price. The portfolio is invested across equities, US TIPS, UK T-Bills, gold bullion and UK Index-Linked Gilts.’

She thinks it likely that Personal Assets will continue to preserve capital in difficult markets and says that it remains a low volatility vehicle that should be capable of delivering attractive absolute returns over the long-term.

UNCORRELATED INVESTMENT TRUSTS to consider

Nick Greenwood, manager of Miton Global Opportunities (MIGO), says that India Capital Growth (IGC) is not particularly correlated with mainstream equity markets and should hold up better than most if president Trump starts a trade war that results in a slowdown in the pace of global trade.

‘The current management team arrived in 2010 and are the third incumbents India Captial Growth’s relatively short but initially disastrous life. They endured a tough time turning around the legacy portfolio, but during the past three years returns have been significantly stronger than better known peers such as JPMorgan India (JII).’

India Captial Growth is trading on a discount to net asset value (NAV) of 22%, and Greenwood says it is a classic example of when a trust discount reflects the track record of the vehicle rather than that of the current managers.

‘India has a more developed equity culture than most emerging markets. The benefits from the arrival of a market friendly majority government focused on removing inefficiencies should feed through into earnings forecasts, a trend which will run for years rather than months,’ says the Miton fund manager.

His second uncorrelated suggestion is the Taliesin Property Fund (TPF), which is a specialist closed-ended fund that invests in Berlin residential property. It is trading at a 26% premium to the latest estimated NAV, but the open market value of its apartment blocks remain well below replacement cost.

The trust is slowly selling assets. The sale of apartments in the first privatised blocks achieved prices of around €4,000 per square metre, which compares favourably with Taliesin’s average carrying value of €2,440 per square metre, a price that reflects the valuation methodology for apartments as yet unconverted from rental use.

‘Those responsible for valuing the properties are likely to bring into consideration permission to privatise a portfolio into their valuation process. This implies a further sharp increase in Taliesin’s NAV. The trust is handing cash back to shareholders from the proceeds of the disposals.’

HEDGE FUNDS to consider

David Coombs, head of multi-asset investments at Rathbones, says it holds commodity trading adviser funds (CTAs) Aspect Capital and Schroder GAIA BlueTrend.

‘These are extremely volatile quantitative trading strategies, but they have very low correlations to equities. And that’s the point: diversifiers should be chosen on correlation, not volatility. That means having nerves of steel, but it can also mean better portfolio performance overall.’

These sorts of trend-following strategies aim to identify price trends in different markets and then take advantage of them. By going long and short in various up and down trends at the same time they can remove much of the systemic market risk.

Aspect has a UCITs version of its fund that is registered in Dublin and that in theory is available to all investors, although you would need to check whether your broker will allow you to invest in it.

A more accessible alternative would be Highbridge Multi-Strategy (HMSF), a listed hedge fund that has been included in the Winterflood investment trust team’s top picks for 2017.

HMSF is fully invested in a global multi-strategy hedge fund run by Highbridge Capital Management. It uses relative value techniques including arbitrage and long/short strategies to target a return of 7% to 12% per year with 3% to 6% volatility and a low beta to the S&P 500.

The investment trust was previously known as BlueCrest All Blue, but since switching the underlying capital to Highbridge at the start of March 2016 the share price is up by about 6%. There is a share buyback programme to control the discount to NAV. The costs are on the high side with estimated ongoing charges of 1.6% excluding performance fees.

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