Smith & Williamson Enterprise, Jupiter Absolute Return and F&C Real Estate Securities are the three funds backed by Chelsea Financial Services for investors concerned by the longevity of the current market bull run. 
Chelsea managing director Darius McDermott (pictured) said with the FTSE 100 recently touching new highs, now could prove a profitable time to switch into strategies with the ability to short the market.
“Since June last year we have observed greater dispersion in stock returns. Post Brexit, stock correlations in the UK reduced, as the market sought to identify winners and losers,” he said. “Post Brexit, stock correlations in the UK reduced, as the market sought to identify winners and losers.
He further noted that the generalised period of QE-driven asset price inflation is likely to be at an end.
“The ‘rising tide’ of QE that floated all boats is now beginning to ebb,” he said. “This means that, as central bank support fades and asset returns become more dispersed, investors will need to be more discerning and focus on idiosyncratic risks.”
Another reason to embrace shorting strategies is the current heightened risks levels globally, particularly geopolitical risks such as unpredictable US president Donald Trump, North Korean missile testing and Brexit.
While new risks have emerged in recent years, markets have remained resilient or complacent, said McDermott, with valuations becoming richer.
“This strength in equity markets has occurred despite uninspiring earnings growth and, more recently, seems to have been more down to the weakening of the pound than to any improvement in earnings forecasts or other fundamentals,” he explained.
The final reason to embrace shorting strategies is analysts’ expectations, which can often have a significant impact on markets.
“At the start of each year, analysts make their (often over-optimistic) forecasts for earnings and other metrics,” he said.
“In the first six months of the year, markets will give these optimistic forecasts the benefit of the doubt, as there is still ample time for companies to deliver the expected run rates or growth rates.
“But, as time passes, and the window for companies to deliver versus expectations either narrows or closes altogether, there is scope for earnings downgrades and a valuation derating.
“We are currently seeing that those highly-rated stocks failing to meet guidance, or those that are issuing profit warnings, are being hit very hard.”
He added: “In this environment, investors who are worried about short-term market weakness can consider funds with the ability to make money when stock prices fall as well as rise.”
Below FE Trustnet explores McDermott’s three fund picks in more detail.
Smith & Williamson Enterprise
The first fund backed by McDermott is the four FE Crown-rated Smith & Williamson Enterprise fund managed by Rupert Fleming, Mark Boucher and Mark Swain.
The management team aims to deliver a target return of 3-month Libor + 4%, irrespective of market conditions on a rolling 12 months basis with low risk and low volatility. The £120m long/short fund invests primarily in UK equities and contracts for difference (CFDs).
Since launch in April 2006, the fund has delivered a total return of 120.45 per cent compared with a 93.52 per cent gain for the benchmark, as the below chart shows.
Performance of fund vs sector & benchmark since launch
Source: FE Analytics
“Unlike many other equity long/short funds, the managers on this fund generally don’t use futures to provide their short exposure, and their shorts aren’t just hedges to dampen volatility but are genuine sources of alpha,” said McDermott.
“This strategy has seen the short side of the fund perform well, even in rising markets, which is reasonably rare and obviously a huge plus for this type of vehicle.”
According to its most recent factsheet, the fund had 42 long positions and 32 short positions. It has a total short exposure of 41.2 per cent and a 54.6 per cent total long exposure.
The fund has returned 4 per cent in the year to 17 October, just ahead of the benchmark’s 3.44 per cent rise.
“As company results and news-flow picks up after the summer, we are seeing an increasing number of opportunities in a market environment that we expect to be good for a long/short strategy such as ours,” the managers noted in their most recent fund factsheet.
The fund has an ongoing charges figure (OCF) of 0.90 per cent. It also has a performance fee of 20 per cent with a high watermark. Last year, the performance fee was 0.7 per cent.
Jupiter Absolute Return
The second fund on McDermott’s list is Jupiter Absolute Return managed by James Clunie. The manager took over the £1.3bn fund in 2013 from Philip Gibbs who retired from fund management in 2014.
“This is a lower-risk option,” said McDermott. “It is predominantly a global long/short equity fund, although the manager does have the freedom to invest in other asset classes where he sees fit.
“He relies heavily on quantitative screening to help inform his long and short stock ideas and runs screens over three different time horizons.
He added: “It is rare to find a fund with such low historic correlation to other asset classes, even in the absolute return space, which may make this fund an effective diversifier and a good complementary portfolio holding.”
Since taking over the fund, it has returned 16.68 per cent compared with a 2.06 per cent gain for its 3-month Libor benchmark.
Performance of fund vs sector & benchmark since September 2013
Source: FE Analytics
The fund is popular among financial advisers and sits in each of the FE AFI indices – Aggressive, Balanced and Cautious – covering all age groups and, as such, is included on the FE Invest Approved list.
“James Clunie has developed a specialisation in short selling,” FE analysts noted. “His capacity to identify overvalued stock, as well as understanding the risk associated with this technique, is a key feature of the fund.
“The manager has used the same strategy since 2009, which he exported from Scottish Widows to Jupiter in 2013.
“He perfectly understands its strengths but also its weaknesses, meaning that he can limit the risk in the portfolio if he believes the strategy can’t perform. It happened several times in the past and the capital loss has been small in those periods.”
They added: “We believe this fund is a useful tool to have in the box when investors expect a shift in the economic regime.”
The fund has an OCF of 0.86 per cent.
F&C Real Estate Securities
McDermott’s final pick is the F&C Real Estate Securities. The only one of the three that doesn’t sit within the IA Targeted Absolute Return sector, the four crown-rated fund is managed by Alban Lhonneur and Marcus Phayre-Mudge.
Targeting a total return greater than that produced by the FTSE EPRA/NAREIT Developed Europe Capped index, the fund invests in property-related stocks from across Europe.
Since launch, the fund has returned 161.7 per cent compared with a 127.8 per cent gain for the benchmark and a 61.12 per cent rise for the average IA Property sector fund, as the below chart shows.
Performance of fund vs sector & benchmark since launch
Source: FE Analytics
“This fund provides access to a portfolio of real estate securities listed in the UK and Europe,” said McDermott. “F&C is one of the bigger players in this space and runs several other similar mandates.
“The size and strength of the team differentiate this fund from some of its competitors. Also, the unique way the managers use the full range of tools available to them, namely by shorting unfavoured stocks, enables them to express a wider range of views and better manage risk.”
The £119.7m fund carries and OCF of 1.37 per cent. It also carries a performance fee of 15 per cent of any outperformance of its benchmark. In the last financial year the performance fee was 0.2 per cent.