Fund ideas for investors worried about a stock market fall

Boom or bubble? This is what investors everywhere are asking about the American stock market after the spectacular rise of AI-related stocks such as Nvidia. Readers of this website are among those worried that valuations have become excessive and that the market may be primed for a fall. Three of those readers have submitted questions for our Ask Fidelity feature to address different aspects of this all-important issue. Here are their questions:

• Should I switch some of my investments to cash and if so what percentage?
• I’m concerned about market valuations and would like to derisk my investments by investing in low to moderate risk income funds. Please can you suggest five funds that would fit this profile.
• I’m invested in passive funds and thinking about introducing active managers to protect from downward market movement. What do I need to think about?

It’s notable that all three questions suggest that readers are reluctant simply to bail out of the markets altogether and put all their money in cash. No doubt they have in mind the view of many professionals that such attempts to ‘time the market’ often fail and that, once out, it can be very hard to decide when to get back in. None the less they are clearly focused on the risks of remaining invested and are considering cash, lower-risk funds and active management as possible solutions. Let’s look at the case for each, along with some fund ideas.

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Switch to cash – and at what percentage?

An outright switch to cash may be sensible if you are on the brink of retirement; less so if you are 21. If you have plenty of time in front of you, markets’ habit of recovering from crashes will stand you in good stead – especially if you continue to invest through the ups and downs and use ‘pound cost averaging’ to buy fewer shares when they are expensive and more when they are cheap.

If you are in this situation but still do not think you could tolerate a severe crash – perhaps you fear it would put you off investing in future – you could cash in a proportion of your stock market investments. There’s no rule for arriving at an appropriate percentage but my feeling is that putting between a quarter and a half in cash, according to the degree of your concern, might be about right.

It’s different if you are much older or have a purpose in mind for some or all of your savings, such as buying an annuity or paying off your mortgage. This is something like my own situation and last year, as I wrote here at the time, I decided to put half of my pension in cash, a percentage I have since increased.

• Read: Six months ago I put half my pension in cash. Did I do the right thing?

Switch to less risky income funds?

There is certainly logic to this approach. A stock that pays an income tends to have reached a certain level of maturity and to be managed in a way to maintain its profits and therefore the income it pays (company executives hate to cut dividends). This tends to make income stocks more stable than the market average. On top of that, the US stock market has a low yield so income funds tend to invest in other markets, such as the UK, which are more moderately valued than Wall Street. Although there is no guarantee that, in the event of a severe fall in America, other markets would not suffer, prices of resilient income stocks can be expected to fare better and recover sooner.

Fidelity’s Select 50 list of recommended funds, chosen by independent analysts at Fundhouse, includes the following income funds:

• Ninety One Diversified Income (4.4% yield)
• ClearBridge UK Equity Income (4.6% yield)
• Vanguard FTSE 250 ETF (a passive fund; 3.8% yield)
• International Public Partnerships (an investment trust; 5.9% yield)
• M&G Corporate Bond Fund (4.8% yield)

Of course, there is always the option of an even less risky ‘cash’ or ‘money market’ fund. The Select 50 includes the Legal & General Cash Trust, which currently yields 4.6%. Please note all yields quoted here are variable and not guaranteed.

Switch from passive to active funds?

This option too has much to recommend it. One of investors’ concerns about Wall Street at present is the degree to which money has flowed into the ‘Magnificent Seven’ stocks at the expense of others. As a result these seven companies account for about a third of the total value of the S&P 500 index, which consists, of course, of 500 stocks. Anyone who owns a fund that tracks this index therefore commits a large portion of their money to these stocks by default. The overall effect, commentators say, is unprecedented concentration of savers’ funds in this one section of the market and the risk of a disorderly unravelling if buyers turn to sellers.

• Read: The investment trusts most exposed to the magnificent 7

Passive funds (unless ‘equal weighted’; see below) have no choice but to reflect the dominance of these stocks in their portfolios. Active managers can put less of their money into them or avoid them altogether. A ‘multi-asset’ fund can go further and even avoid the stock market altogether; a multi-asset remit for a fund gives the manager more flexibility to make big changes in response to events. You could also of course choose funds that invest entirely in assets other than stocks, such as bonds or infrastructure investments.

Our Select 50 includes these multi-asset funds:

• Ninety One Diversified Income
• Pyrford Global Total Return

Options outside the Select 50 include the Troy Trojan and CG Absolute Return funds and the Ruffer, Capital Gearing and Personal Assets investment trusts.

Away from multi-asset funds, here are some actively managed options, chosen to offer a range of asset types, from the Select 50 (some featured among our income-focused ideas above):

• M&G Corporate Bond Fund
• First Sentier Global Listed Infrastructure Fund or International Public Partnerships
• ClearBridge UK Equity Income Fund
• Fidelity Global Dividend Fund
• Dodge & Cox Worldwide Global Stock Fund

If you were prepared to consider passive funds, those that hold ‘equal weights’ of every constituent, rather than the usual practice of sizing holdings in proportion to the value of each stock, avoid the problem of concentration in a small number of companies. Here are a couple of equal-weighted trackers (the first is from the Select 50):

• Legal & General S&P 500 US Equal Weight Index Fund
• Invesco MSCI World Equal Weight ETF

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Before investing, please read the relevant key information document which contains important information about each fund. Select 50 is not a personal recommendation to buy or sell a fund. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.