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Protect your portfolio against risk of market drops

By Nick Paler

After dramatic rises for stock markets over the past three years, 2014 has been tougher, with the FTSE All Share rising this year by just 2.4%. But the largest UK stocks are trading just shy of record highs while the US markets are already at fresh peaks.

That leaves investors rightly concerned over valuations, especially with so many economic problems unresolved around the globe.

So how do you plan to protect your portfolio against the risk of markets going south?

Looking back over the last three corrections for the FTSE All Share – periods in 2010, 2011 and 2012 which saw it tumble by more than 10% from peak to trough – reveals a number of consistent winners which helped protect investors.

Fixed income: Data from FE Trustnet shows there are some sectors investors can shop around in to find protection from any severe UK market fall.

The most recent correction, between March and June 2012, wiped 11% off the FTSE All Share in three months.

But while equities fell, seven sectors returned positive gains.

UK government debt was the top performer, with UK Gilt and UK Index-Linked gilt funds climbing 7.2% and 6% respectively. Strategic and Corporate Bond funds were other areas which protected investors.

It was a similar story in the corrections of 2011 and 2010, with most bond fund sectors averaging a positive return.

But while bonds appear the obvious answer, some experts say the next correction may not be so favourable for fixed income funds.

James Bateman, head of multi-manager and multi-asset funds at Fidelity Worldwide Investment, says he is worried about the growing threat of an interest rate hike in the UK which could leave gilts not providing the protection investors seek.

"Almost every market correction has come at a time when interest rates were high, but now we are at record lows it is unusual," Mr Bateman says.

"If there is a correction in the near future – and I think it's coming at some point – I don't think it would change the outlook for interest rates, which are clearly pointing upwards."

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