Fund strategies: numbers add up for agile active funds

Recovering from losses can be tough going. If the market and an investor's portfolio drops by, say, 20%, a rise of 25% is required to get the investor back to where they started. The importance of avoiding such falls is something Saltydog is well aware of.

Over the past four years, there have been five notable market falls, any one of which could have turned into a major correction. The world has become highly volatile, many political problems appear to be insoluble, and solutions to economic difficulties are proving elusive.

The only sensible strategy for investors is to keep on top of their investments and be as active with their portfolios as a given situation demands.

It is possible (as the first graph, click to enlarge, shows) to avoid market dips by being active and operating a "cautious-risk pie chart" (below) to take you through these turbulent times.

Groupings

I fail to understand the rationale of advocates of passive investing. What can possibly be gained by sweating like an ice cube in the summer sun while the markets do with your portfolio what they will?

Saltydog's approach is to divide the 30 or so Investment Association fund sectors into five groups based on the historical volatility of these sectors.

In a nod to my early life in the Merchant Navy, these groups have been given nautical names that instantly indicate the risk level associated with the group. In order of rising volatility, these groups are:

Safe haven: cash and cash-equivalent funds.

Slow ahead: mainly fixed-interest funds such as bonds and gilts.

Steady as she goes: predominately equity income and managed funds.

Full steam ahead developed: funds investing in small or large companies in developed markets.

Full steam ahead emerging and specialist: funds investing in small or large companies in the emerging markets, and funds from specialist sectors such as Latin America, Russia, India and biotechnology.

With these groups established, we can construct a risk pie chart by allocating a percentage to each group. This reflects Saltydog's approach to risk under normal circumstances; when times get tougher, its algorithm will move the percentages to adopt a more secure position (see the panel below).

Weekly changes

This is not a "bodge it and scarper" approach: Saltydog makes weekly changes if the situation and risk chart demand that it should. This entails making adjustments to the funds in the portfolio, even to the extent of letting go of successful funds in the more volatile groups.

The cautious Tugboat portfolio has a baseline allocation of 70% in the slow ahead group. This means the portfolio managers constantly look for sectors and funds in this group that perform when they need them to. In the past few years, these have varied from UK gilt to strategic bond funds and other sectors.

Over the past 18 months, what we call the slow property sector has featured prominently - particularly via M&G Property Portfolio, Aberdeen Property, Threadneedle UK Property and Standard Life UK Property.

These four funds have clicked up nicely by between 0.7 and 1.0% at the end of each month, irrespective of performance elsewhere. This has mitigated the effect of market falls when they have occurred.

The remaining 30% of the portfolio is mobile: it is moved around the more volatile groups from sector to sector as the performance numbers demand, but it stays within the group percentages, as required by the risk chart.

Saltydog has been fortunate that this has allowed it to follow biotech, India, and Japan funds at times when these sectors were performing well, albeit with just a small percentage of the portfolio. The results (see graph) speak for themselves: falls have been avoided and the portfolio has returned nearly 50% over the past four years.

This can only be achieved by accessing accurate, up-to-date fund performance numbers. Every week, Saltydog makes decisions based on the top-performing 20% of funds in each sector over four, 12 and 26 weeks - not for us the one-, three- and five-year performance numbers.

The world has moved on from the time when ships sailing for the New World were told to sail south until the butter melted, and then turn west.

Douglas Chadwick is a founder director of Saltydog Investor.