This week, with the FTSE 100 index closing the week up 1.4 per cent, some portfolio managers have disclosed that they are buying back into the equity market, following its 15 per cent fall since the beginning of August.

But for private investors seeking to protect their portfolios and rebuild their pensions, a balance between further risk and future returns is recommended.

I’m worried about continuing volatility – but traditional ‘safe haven assets’ look overpriced. Are there other ways to protect my capital?

You are not alone. Independent wealth manager Signia Wealth, which has already cut its clients’ equity exposure from 50 per cent to “low single-digits”, warned this week that “volatility is likely to remain prevalent for the remainder of 2011.“ PSigma Investment Management also noted that the only assets to have provided a return uncorrelated to equities, and downside protection, look risky at current prices. “If, as we do, you think bonds are incredibly overvalued and gold is in the mid-stages of a bubble, and both of those asset classes could fall long and hard, trying to build protection into portfolios is tough,” said chief investment officer Tom Becket.

Discretionary portfolio manager Gore Browne said a capital preservation strategy must avoid investments with high historic volatility: direct shareholdings and most commodities. It suggested holding a widely-diversified spread of assets with historically low correlations to each other, such as bonds, infrastructure investments, property and hedge funds.

PSigma also favoured hedge fund strategies, via absolute return funds that take long and short positions in equities. “Our method of choice has been to employ fund managers in alternative funds who have been able to short investments well,” said Becket. “Our ‘alternatives’ weightings are now at the highest they have been.”

Bonds are still recommended by Signia. “We have increased allocations significantly to long-dated US and UK government bonds, which have performed very well against a back drop of systemic concerns and slowing economic growth,” said chief investment officer Gautam Batra.

In addition, a number of managers said they were holding cash, and starting to drip feed slowly it back into equities.

How diversified do my investments need to be, to provide capital protection?

HSBC Private Bank has recommended a diversified short-term asset allocation, as its view is that “volatility continues”. It suggests government bonds of medium duration, investment grade corporate bonds, some non-financial shares, and “safe haven” assets in Swiss francs, Japanese yen and emerging market currencies.

Gore Browne said its capital preservation strategy allocated 45 per cent to bonds and fixed income, 20 per cent in multi-asset funds, 15 per cent to hedge funds, 10 per cent to infrastructure assets and 5 per cent each to gold and property.

Rathbones suggested its Total Return model portfolio for investors seeking to lessen the impact of equity market volatility. This holds 23 per cent overall in UK and overseas equities, 28 per cent in government a corporate bonds, and 30 per cent in various hedge funds (see chart).

PSigma said it has more than 12 different asset classes in its balanced portfolios, but used funds to gain exposure to hedge fund strategies: the long/short Melchior European Absolute Return fund and the Henderson Credit Alpha fund.

What if I have a longer time horizon, and don’t need access to my money for five years or more? Is now a good time to invest?

Some fund managers think so. Earlier this week, Sanjeev Shah, manager of Fidelity Special Situations fund, said the recent stock-market falls offered the best opportunity for long-term equity investment since the market low of March 2009. He suggested focusing on companies with sustainable sales and earnings growth, such as BSkyB, mobile telecoms stocks, such as Ericsson, and fast-growing online businesses such as Moneysupermarket, IG Group and Ocado. He has also started buying shares in companies that “would normally perform well in the early stages of an economic recovery”, such as builder Wolseley, retailers Marks and Spencer and Home Retail Group, and gaming group Ladbrokes.

Shares in companies with “high quality global franchises” are recommended by PSigma, via funds such as Morgan Stanley Global Brands and MFS Global Equity. Out-of-favour cyclical companies are also worth considering, he said, via the River & Mercantile Long Term UK Equity Recovery fund. But he added that high-yield bonds with a short duration focus may be a better option for less confident investors, as they offer yields of 8 per cent “with significantly less volatility than equities” and low risk of default. He recommended the Neuberger Berman High Yield and Muzinich Short Duration High Yield Credit funds.

Willem Sels, UK head of investment strategy at HSBC Private Bank, suggested longer-term investors could consider shares in European industrial companies and even European banks, as they “are likely to be one of the highest beta assets – if all riskier assets rally, they may rally most sharply. Shah preferred non-banking financial stocks such as Land Securities and London Stock Exchange.

If the market volatility is linked to debt worries in the Eurozone and US, should I be investing further afield?

Yes – both fund managers and discretionary portfolio managers recommend exposure to emerging markets. Rathbones Enhanced Growth model, which is designed for high-risk investors looking for capital growth over a five to ten-year time horizon, holds 35 per cent in emerging market equities. “The investment objective allows significant exposure to emerging markets which we believe will outperform over the longer term given superior economic growth in this area,” according to the managers.

However, Shah at Fidelity said he preferred to gain exposure via companies exporting to emerging markets. “I believe the emerging market consumer theme will continue for the next several years, which is why I am happy to have large positions in Burberry and L’Oréal,” he said.

Emerging market currencies also provide opportunities, said Sels. “Many have been relatively resilient… we prefer EM currencies in countries that have solid government finances and current accounts and have a large domestic market that makes them less dependent on the weakness in the world economy.”

Signia said it was combining exposure to “the Chinese consumer through better quality individual securities”, holdings in companies involved in Japanese reconstruction.”

PSigma claimed Japanese shares now represented a favourably “asymmetrical trade”: upside potential of 100 per cent, with downside of “probably only 10 per cent“. Its recommended Japanese fund is Jupiter Japan Income.

I’m worried about how much the value of my pension has fallen in the past month but I don’t retire for another ten years. Should I sell my equity holdings and move into something safer?

John Lawson at Standard Life warns that selling any equity holdings in your pension would just crystallise your losses, urging those further away from retirement to “hang tight”. In fact, Laith Khalaf at Hargreaves Lansdown says that for long-term pension investors, now could be a good entry point into the market for any cash you have sitting on the sidelines. The stock market is now about 15 per cent cheaper than it was a month ago.

If you’re really worried by markets, you could start paying new pension contributions into a different fund that’s less volatile. Lawson says that absolute return or structured funds offer some equity exposure while protecting on the downside – but be aware you’ll sacrifice some of the upside in return for your peace of mind.

Those really worried can continue paying into their pension but park the money in a cash account, available in self-invested personal pensions. That way you can decide where to put the money later when markets are calmer.

I am about to retire and can’t put it off, but my pension pot has fallen in value. Is there anything I can do?

You don’t have to cash in your whole pension for an annuity at once. Lawson suggests just cashing in a part and living off the tax-free cash, which is 25 per cent of the value, for a year or so. Then you can cash in the rest of the pension after it’s had time to grow if markets improve. Especially as annuity rates are currently at historic lows, which creates a double whammy with bad markets right now.

Khalaf points out that shopping around for the best annuity rate – and not just buying the annuity offered by your existing pension provider – can mean up to 40 per cent more income every year for the rest of your life.

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