Three steps to prepare your portfolio for market falls

A survey of AJ Bell Youinvest customers has shown that, despite a rebound in markets since March, investors still have a very gloomy outlook for the UK economy and think the worst is yet to come for stock markets. When asked if the worst of the current downturn is over, 51% of people think that there is more bad news to come and that markets will fall further.

What’s more, half of people think that the FTSE 100 index will end the year below its current level, which is approaching the 6,000 mark, while another quarter think it will end the year at the 6,000 level. The FTSE 100 has been on a rollercoaster ride this year, reaching as high as 7,675 in January this year before falling to a low of just under 5,000 in March.

But there is still some optimism out there among investors: 39% of people think the market has seen its worst falls, while a particularly bullish one in eight people questioned think it will return to its previous high within a year. What’s more, just over one in 10 people think the FTSE 100 index will end the year above 7,000, including 2% who think it will sit at 8,000 or above – a high the blue-chip index has never hit before.

Those who think the worst is yet to come can prepare their portfolio now for future falls. This includes ensuring they’re not overexposed to one area or market, making sure they have a good spread across asset classes and putting some money in more cautious funds that may be more able to ride out a recession or another downturn. Here are three steps that could help prepare your portfolio for market falls.

1. Spread your eggs around

The recent falls in equity markets have been a wake-up call for many investors that they had too much risk in their portfolio – and too many of their assets in the stock markets. Investors who think bigger market falls are yet to come may want to diversify some of their money into other asset classes that may be less affected, such as bonds, infrastructure, other real assets and even cash. Look at how much you have in each sector, asset class and country and assess whether you need to rebalance.

2. Check your concentration

It’s not just a spread between asset classes that you need to think about, but also making sure you don’t have too much money in a handful of companies. This is trickier if you invest in funds and investment trusts, as you need to make sure they don’t have too much overlap in their holdings.

For example, anyone with exposure to oil companies has been hit by the oil price war and subsequent plummeting oil price. This should be ok if you only have a small portion of your portfolio exposed to these companies, but if you discover that lots of your fund managers own these same stocks you’ll see a much bigger impact on your portfolio.

Monthly fund factsheets only usually have the top 10 holdings on them, but you can still check there isn’t too much crossover in your funds’ biggest positions. Annual reports on funds will have more details on full holdings, but will be more out of date as they are only published once a year.

3. Assess what you’re investing for

If you think markets are going to be turbulent for a long time, you need to make sure you’re investing for the long term. If you know you’ll need access to the money in the next couple of years, for example for retirement or to buy a house, you should think about gradually de-risking your portfolio so you’re not exposed to swings in the market when you need the money. No-one wants to be a forced seller just after markets have fallen, but likewise no-one wants to have to delay big events like retirement or a house purchase because their investment pot has taken a big hit.

Invest in funds that protect against falls

Investors might want to shift some of their fund exposure to those managers whose investment styles could do well in a downturn, and help to protect their money during any falls. One option is the Personal Assets investment trust, run by Troy’s Sebastian Lyon. The £1.2bn trust invests in a range of assets including high-quality companies, short-dated government bonds, cash and gold. It currently has about 40% of the portfolio in US and UK Government bonds and another 10% in gold, meaning it is positioned fairly defensively. Mr Lyon focuses on avoiding loss of capital, as well as giving an instantly diversified portfolio in just one holding. So far this year the trust has grown by 2.2%, while markets fell by far larger amounts.

Another option is Janus Henderson UK Absolute Return. This £1.5bn fund has held up well in recent market volatility and protected against losses – since the start of the year it has risen by 1% when markets have fallen by much more. The fund aims to deliver a return above zero, typically over a 12-month period, and has managed to do so every year for the past 10 years. Managers Ben Wallace and Luke Newman have the ability to have a significant amount in cash, to protect against stock market falls, and to ‘short’ stocks to help when markets are falling. However, the compromise here is that it charges a performance fee of 20% and its annual costs are pricey, with an OCF of 1.05%.

For those who want to remain in equity markets, Evenlode Global Income could also work. The fund invests in around 40 large companies around the globe, offering some diversification between different countries and markets. The fund managers hunt out holdings that have low levels of debt, high profits and require less capital to operate than their competitors, meaning they should be better placed to survive a downturn. While 41% of the £520m fund is invested in US firms and another 23% in UK companies, there’s a spread across smaller European and Asian markets too.

Source: Figures from a survey of 2,412 AJ Bell Youinvest customers between 01/05/20 - 06/05/20