It feels as though markets could be approaching a tipping point and there are various options available to investors to deal with the changing environment, according to Walker Crip’s model portfolio manager Gary Waite. 
As such, having long been underweight fixed income, the manager said he has also tempered down his expectations for equities more recently as they look “fully valued”.
While he is overweight alternatives, Waite (pictured) noted that there are many funds within the absolute return sector that have underdelivered in recent years.
Indeed, for investors looking to navigate the potentially changing environment it can be tricky to know how to prepare.
Below the manager explains the strategies he uses within his models, noting that all would work equally well but that a blended approach will have the most success over a full bear market.
The first strategy, according to Waite, is to continue to ride the market higher until it turns and get out when you can.
There are many adages around attempting to time a bear market: ‘the window is wider on the way in than the way out’, ‘the market can behave like a balloon – slow to get air in but quick to let it out’.
However, even if investors do not time the exact moment the market turns, Waite said that it is “intuitively right” that if investors sell at some point when they can, this is preferable to backing out early.
“The big caveat is investing in large-cap liquid names where you are able to get out when you want to at a price,” he said.
It is when you are dealing with some of the smaller companies in the FTSE AIM or FTSE 250 that it presents problems, the Walker Crips manager noted.
Performance of indices in 2008
Source: FE Analytics
As the above chart shows, in 2008 the large-cap FTSE 100 index fell by 28.33 per cent while the FTSE Small Cap index lost 43.91 per cent, a potentially harmful situation for investors as smaller, less-liquid stocks that can be more difficult to exit.
“Because we have been in such an extended bull run since the financial crisis it appears to me that people have forgotten what it is like to get out of something and it causes you real pain,” Waite explained.
“At the end of a cycle or when it is turning – and it almost feels like we are now there – you wouldn’t want to be in all of those smaller names that might make you 20 per cent [in the bull market] but lose you 20 per cent [in the bear market] because my bet is that you are more likely to lose than win.”
For those looking for a more suitable defensive strategy, Waite said as well as running a small overweight to equities he also owns infrastructure funds – although these offer less protection now having been run up in recent years.
“We have infrastructure funds but because they have had a very impressive recent time they are not as defensive as they once were,” Waite said.
“We still hold them because they are a bond proxy. You have stable cash flows but the market has bid them up because everyone is searching for yield at a price.”
These strategies have proved particularly popular with investors that are worried about bonds, including Waite.
Performance of index over 10yrs
Source: FE Analytics
“A bond market liquidity crunch would make the property market liquidity crunch we had a little while ago look like a storm in a teacup,” he said.
Again his preference in the infrastructure space is for large-cap listed names for liquidity purposes as, although it may mean he could miss out on marginal alpha, it means the funds are unlikely to need to gate – like some property funds were forced to in 2016 following the Brexit vote and a run on the asset class.
Another strategy that he employs is the use of gold and cash – traditional hedges during times of market concern.
However, this is a recommendation as a smaller part of an overall portfolio rather than outright positioning as it relies on timing the market and can take into account commodities, foreign exchange rates and other factors.
The final recommendation for the end of a bull run is the absolute return sector, despite noting that there are some funds that underperform.
“The dream is that I am going to hold this asset so that no matter what markets do it is going to give me a steady return, but the fact is that they don’t and a lot of them are equity proxies,” Waite said.
“They take risk when markets are going up and then, hey presto, as soon as the market falls they are down as well but we don’t buy them for that.
“We buy them for genuine diversification and that defensive part of the portfolio that is going to give us consistent yield and returns when markets are falling.”
The Walker Crips manager noted that some funds have too many positions that can equal each other out meaning the returns are muted.
Funds that he holds across the model portfolios include the Jupiter Absolute Return and Natixis H2O MultiReturns funds.
Performance of funds over 5yrs
Source: FE Analytics
While the Jupiter fund, run by James Clunie, has had low volatility over the past five years, Jeremy Touboul and Vincent Chailley’s Natixis fund is a more volatile product.
“We are quite comfortable to be holding them because we do like managers to have the ability to short – to make money from the downside,” Waite said.
“When we are in this environment, if we believe we are at that tipping point, we want at least a chance for our underlying holdings to give us some alpha or even to reduce the losses of a straight long-only equity and bond portfolio.”