Equity venture aims to combat volatility

Fund investors concerned about market volatility will soon be able to reduce their risk of losses without relying on derivatives or third-party guarantees.

On September 13, Fidelity International is to launch a new fund called Equity Growth Defender, which will move money out of shares and into cash when markets are falling, with the aim of protecting at least 80 per cent of investors’ capital.

At launch, the fund will be invested 100 per cent in equities. If the fund’s price starts to fall, this equity exposure will be reduced and the amount held in cash increased. If the fund’s price then rises, the equity exposure will be gradually increased again. It will be up to the managers to hold enough cash at any given time to ensure the fund’s price cannot fall below 80 per cent of its highest-ever price.

For example, an investor buying into the fund at a price of 100p at launch can expect the fund price not to fall below 80p. If the price then rises to 133p, the target level of protection will increase to 80 per cent of 133p, ie 106p – and this protection will apply to all investors, no matter what price they bought in at. But if the price subsequently falls, say to 115p, the managers will still aim to hold enough cash to prevent it going lower than 106p. This target level of protection will remain in place until the price reaches a new high, when the ‘protected’ level will ratchet up again.

Fidelity says the protection will be provided solely by this investment strategy and the managers “will not buy any additional protection via a contract from a third party”, such as an option, swap or other derivative. However, it admits that the protection is “not a guaranteed result” and the fund may underperform in rising and recovering markets.

Analysts warn that this risk of underperformance is an inevitable consequence of moving the fund’s asset allocation in line with volatile share prices. “This week, the FTSE 100 has moved between 5150 and 5300,” points out Tim Cockerill, head of collectives research, Ashcourt Rowan. “Do they shift the allocation every day? In these markets it’s very hard to see when a trend has set in.”

Moving in and out of equities will also incur costs on top of the fund’s total expense ratio of 1.46 per cent. “In a volatile market moving sideways in a wide range, transaction costs can escalate but the fund goes nowhere,” says Brian Dennehy of independent financial advisers Dennehy, Weller & Co.

Adrian Lowcock of Bestinvest believes buying opportunities will be missed: “If the market fell 20 per cent, they would have to cash in most of the portfolio, just when it might be the best time to buy.”

Cockerill suggests a similar approach can be taken using cash deposits and a simple index tracker exchange traded fund – or buy buying an equity and bond fund such as Investec Cautious Managed.

Dennhey prefers bond funds that have shown “proven capital preservation… in extreme market conditions”, such as M&G Corporate Bond, Newton Global Dynamic Bond, Schroder Strategic Bond and Insight Absolute Insight.

But Lowcock believes Fidelity’s fund may prove more appealing to cautious investors than derivatives based products. “It does fit in somewhere between structured products and perhaps the current absolute return funds,” he says. “Charges are low – a 1.25 per cent annual management charge is very attractive compared to the fees paid for on structured products.”