Have defensive funds delivered during market sell-off?

The one thing stock markets hate more than anything else is uncertainty, which is why US shares started to fall over a month before US president Donald Trump laid out his tariff plans last week.

Since Trump’s “Liberation Day” on 2 April stock markets have sold off heavily, with Asian markets registering big falls overnight and the UK’s FTSE 100 index down over 4% this morning to trade at around 7,720 points.

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The market sell-off reflects concerns over the impact Trump’s tariffs will have on various sectors and industries, and by extension the global economy. Inflationary pressures are expected to reignite, while the odds of a US recession are growing.

At such times, as we pointed out last week, it’s important for investors to keep a cool head and remember that over the long term history shows that stock markets do recover from crises.

For investors, the key is to be diversified. Owning a mix of different investment types, both shares and bonds, helps to shield portfolios against stock market volatility.

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Below, we look at how defensive funds have fared since US stock markets started their descent on 19 February. The data, sourced from FE Analytics, is to 4 April.

Over that period, the average North American fund has lost -16.5%. US funds focused on smaller companies have fared worse, down -21.1%, while the average technology fund has declined by -22%.

Low-risk multi-asset funds

In theory, multi-asset funds, owing to their diversification through investing in both shares and bonds, should be better equipped to weather a market storm than equity funds that invest globally or in one particular region.

The “safest” of the four multi-asset sectors – the Investment Association (IA) Mixed Investment 0-35% Shares sector – would usually be expected to protect capital best when stock markets are volatile, due to having only a small weighting to shares.

This has proved to be the case, with the average fund in the IA Mixed Investment 0-35% Shares sector down -2.2%. Multi-asset funds with a higher percentage to equities, but plenty of bonds, have also limited losses. The average fund in the IA Mixed Investment 20-60% Shares sector is down -4%.

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60/40 strategy

Normally, when share prices fall sharply over a short period, the defensive qualities of bonds are paramount. It is the reason why, historically, the 60/40 portfolio (60% in shares and 40% in bonds) has served investors well.

While equities provide the growth, bonds help bolster income and should make your portfolio less volatile, as generally they rise in value when equities fall. However, this was not the case in 2022 when interest rates rose, which caused both shares and bonds to unusually post losses over a 12-month period. 

A popular fund that follows this approach is Vanguard LifeStrategy 60% Equity. It invests in various index funds managed by Vanguard, which aim to mirror the returns of specific stock and bond markets. Over the period, the fund is down -8%.

Some commentators think the 60/40 portfolio may not be as effective in the coming years as it has been in the past if inflation rears its head again. Those in this camp advocate including other defensive assets, such as commodities, and to prioritise particular areas of the bond market, such as US Treasury Inflation-Protection Securities (TIPS).

Capital preservation-focused investment trusts

There are a handful of wealth preservation investment trusts that prioritise protecting investor capital. Therefore, when there’s a stock market sell-off, such trusts should keep losses to a minimum.

Three trusts that meet this description are Capital Gearing (LSE:CGT), Personal Assets (LSE:PNL) and Ruffer Investment Company (LSE:RICA). Each has a low weighting to equities and plenty of defensive armoury, such as low-risk inflation-linked bonds and a small weighting to gold.

Ruffer Investment Company has managed to make money during the sell-off, posting a gain of 2.8%. Both Capital Gearing and Personal Assets have held up well too, limiting losses to -1.4% and -2.1%.

Volatility managed and targeted absolute return

Two other defensive sectors are volatility managed and targeted absolute return.

The average volatility managed fund is down -5.8%. Such funds target a specific risk or volatility outcome.

The targeted absolute return sector has held up better, with the average fund down 0.9%.

However, the targeted absolute return sector is a tricky one for retail investors to navigate. Some funds are aggressive (shorting stocks, for example), while others are more vanilla in attempting to deliver slow and steady returns.   

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Money market funds

Money market funds are one of the lowest-risk ways to earn a return on cash, with such funds offering yields of around 4.5% at present. Such funds own a diversified basket of safe bonds that are due to mature soon, normally within just a couple of months, as well as “money market” instruments such as bank deposit accounts.

During the sell-off, the average fund gain was 0.5% for both the IA Short Term Money Market and IA Standard Money Market fund sectors. Royal London Short Term Money Market, the most-popular money market fund on our platform, returned 0.55% over the period.

However, bear in mind that while cash is a useful asset class, particularly during such turbulent times and when it’s paying a good level of income, over the long run having too much in cash can harm long-term returns.

Gold

Gold is a Marmite investment. Some argue that a small weighting to gold is beneficial over the long term as a portfolio diversifier due to its ability to act as a safe haven in troubled times. Others, however, steer clear of the yellow metal due to price volatility and the lack of a dividend. 

However, over the past year to 18 months, gold has proved its worth as a hedge against rising geopolitical tensions. Over one year, the gold price has risen from $2,337 to $3,025. Funds that invest in gold – both those that passively track the gold price and those that invest in gold mining shares – have delivered good performances.

For example, iShares Physical Gold ETC (LSE:SGLN), one of our Super 60 investment ideas, is up 30.2% over one year.

The currency hedged version, iShares Physical Gold GBP Hedged ETC (LSE:IGLG), means that movements in the pound/dollar exchange rate do not affect performance. One sometimes under-appreciated risk with gold for UK-based investors is that because it is priced in US dollars, currency movements can impact its value in sterling terms.

When the US dollar falls in value vs the pound then the value of gold holdings will also fall. Since the middle of January this year, the dollar is down -5% against the pound, which would have hurt returns on any unhedged gold holdings for UK investors.

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During the sell-off, gold also proved its worth as defensive ballast, with iShares Physical Gold ETC up 1.7%. The hedged share class has fared better, up 4%, while also having a slight edge over one year, up 32.5%. 

Gold’s safe-haven status is down to the metal being a tangible asset and a reliable store of value. This is because governments and central banks cannot simply print more gold, as they can currencies. As a result, its value is preserved.

Equal-weighted ETFs

Ahead of the sell-off, the US stock market had become increasingly concentrated due to strong performance in 2023 and 2024 from a handful of large-cap technology stocks. The so-called Magnificent Seven accounted for around a third of the S&P 500 index.

For investors concerned about concentration risk, we previously flagged that one option is to consider index funds and exchange-traded funds (ETFs) that track an equal-weighted index, which holds each company in equal proportion. For example, an equal-weighted FTSE 100 index would have a 1% weighting to each constituent.

One of the main benefits is that an equal-weighted ETF avoids being overexposed to stocks that have become overvalued or, worse still, potentially part of a bubble.

While investors would not expect such an approach to protect capital when stock markets plunge, the equal-weight approach has fared better during the sell-off than the more common market-cap weighted approach. Invesco S&P 500 Equal Weight ETF (LSE:SPEX) is down -12.5%, while Vanguard S&P 500 ETF (LSE:VUAG) has lost -19.5%.