Funds designed to cope with rising and falling markets

Inspiration for writing this column two weeks ago came from my wife's attempt to photograph me with a fake Russian soldier standing in front of the Brandenburg Gate in Berlin.

You may recall that she failed to capture any sign of the famous bronze horses that stand proudly on top. Well, imagine my surprise, while conducting my research for this week's offering, to find an article on the Citywire website that featured the missing bit of the Brandenburg Gate, fully resplendent with all the bronze horses on top.

Clearly, the Citywire photographer knew a thing or two about composition and I was naturally attracted to the article. It referred to the keynote speech at a recent Citywire conference in Berlin, given by Norbert Walter, the former Deutsche Bank chief economist, who issued a devastating warning to the investment industry to expect troubled times ahead. His biggest worry was the demise of democracy, no less.

Well, this certainly is a bit of worry since it would take a large chunk of capitalism with it, thus changing the very nature of investment opportunities, not to mention our comfortable lifestyles.

According to Mr Walter, the direct result of the recent financial and economic crises is that developed countries, which were once the drivers of economic policy, are now being undermined by key emerging economies. He said Wall Street and the City of London must understand that the party is over, and that the US would learn the hard way that it did not have a monopoly on world currency regulation. He wasn't too optimistic about Europe either, suggesting there is a high risk of regulatory disaster as governing bodies provide "a lot of talk for a lot of inaction".

Well, this is all a bit frightening.

Until a few weeks ago, things were looking pretty rosy. Stock markets were rising, US third-quarter GDP had been revised up, retail sales and industrial activities were doing well, corporate profits were near record highs, retailers were forecasting a healthy Christmas shopping season and Europe had reported better-than-expected manufacturing data for November.

Despite these good indicators, equity markets have recently fallen in response to other depressing events.

Firstly, there is the second attempt by the US to pump money into its economy with its QE2 (quantative easing) initiative. This is a techno-jargon word for printing money with no supporting economic activity to justify it.

Secondly, the EU lurches from one default crisis to another. It started with Greece; now it is Ireland whose banks need a staggering amount of money to ensure its economy does not go under. Portugal is not far behind and, if Spain follows, the euro and the EU will be under serious threat, if not extinction.

If that is not enough, China is reining in its economy in response to higher-than-expected inflation, which non-Chinese experts estimate at 7 per cent to 9 per cent per annum (nobody trusts the official figures).

Interest rates are rising, bank lending is being curtailed and demand for foreign imports will undoubtedly fall.

Back in the US, equity markets are reeling in response to the FBI's investigation of insider-trading allegations in the US hedge-fund industry. Investors are selling stocks that these hedge funds hold in anticipation of massive liquidations. And finally, we have the threat of war as the two Koreas slug it out.

With such conflicting information, it is not surprising that opinion on future investment performance is divided. So what to do? If you are sitting on a large investment portfolio and are concerned about losing capital, then you need to reshape it with an asset allocation that matches your attitude to risk.

Essentially, you need to decrease equities in favour of bonds, structured products, hedge funds and cash.

Alternatively, exchange your growth stocks for ones that produce high-dividend yields, swap small companies for large ones and buy protection using "put" options.

I conclude with a brief description of three funds that are designed to cope with rising and falling markets.

- Man AHL Diversified (managed futures hedge fund): as well as generating attractive performance, the key feature of hedge funds is their potential to make money when conventional markets are falling. Their performance is said to be "uncorrelated" with that of equities and bonds and, therefore, they can reduce volatility when added to a conventional portfolio. This is an extremely important characteristic of hedge funds. Man AHL Diversified has delivered 18.2 per cent for the year to date with an impressive 8.4 per cent in October alone.

- GLG Emerging Markets Fixed Income and Currency (UCITS III) Fund: this fund seeks capital appreciation through investment in bonds, currencies and related derivatives in the emerging markets of Asia, Latin America, Eastern Europe, the Middle East and North Africa. It uses investment strategies that are designed to produce a positive "absolute" return no matter what is happening in the underlying assets. It does this by using a diversified portfolio of both long-term positions and short-term tactical trading. Year to date (end of August), it had returned 6.8 per cent and has averaged 8.2 per cent per annum since its inception in July last year.

- Emirates Islamic Money Market Fund (Emirates NBD Asset Management): have you noticed how your US dollars invested in your offshore bank account is paying virtually zero interest and how your local account in the UAE is paying you 3 per cent per annum on dirham deposits? Well, that's because the local banks are more desperate for your money. You can now capitalise on this phenomenon by buying a fund that invests in local currency markets. Although the disparity between Libor (0.286 per cent per annum) and Eibor (2.1475 per cent per annum) is tightening, the fund continues to prosper. The current yield is 3.7 per cent per annum. This fund is not going to shoot the lights out, but it is a useful place to park your money while you think of something else to do with it.

Bill Davey is a financial adviser at Mondial-Dubai. If you have any questions on this column or any other financial matter, he would be happy to hear from you at bill.davey@mondialdubai.com