When markets are uncertain and mainstream asset classes offer an unattractive risk/return trade off, where can investors go to find low volatility and inflation beating returns?

Individual investors have historically turned to fixed term deposits with a bank or building society when they seek a return on cash with low risk of loss.

In the past, the capital has been perceived to be safe, though the returns have typically not been high (on average 2% above inflation) and investors have to wait for the deposit to mature to receive the return of their capital.

In the present environment not only are returns on deposits unattractive (a 1% deposit rate is in line with core inflation) but also the security of even the largest bank can no longer be taken for granted.

Gilts retain their ‘safe haven’ status even though they offer very low returns at present with the risk of short term capital loss. After adjusting for inflation, yields on gilts are now negative. This means there will be a natural tendency for yields to rise (and prices to fall) as the global economy recovers and the recent rise in the oil price and the depreciation in sterling lead to higher inflation.

Many investors think of blue-chip equities as being safe over the medium term and perceive the income produced from dividends as reliable. However, not only are share prices vulnerable to significant downside risk (the FTSE 100 fell by 47% from peak to trough in the financial crisis) but dividends on the 350 top UK companies fell by 20% between April 2007 and April 2009, on average.

For those wishing to avoid the emotional rollercoaster of capital losses and intermittent declines in income, a judicious blend of alternative investments might be attractive.

Low volatility alternatives

A relatively new asset class, with little correlation to equity or bond markets, can now be used by experienced investors. Low volatility alternatives have gained support among institutional and retail clients alike since the 2008 financial crisis and are particularly relevant now as we enter a period of uncertainty following Brexit and with US elections on the horizon.

Low volatility alternatives should only be considered by those experienced in investing in alternative assets. Some investments within the alternative space carry higher regulatory, credit and liquidity risk. The results can be attractive and stable when combined into a portfolio. Here are some examples:

Asset backed investments. These include loans such as those issued to farmers to purchase agricultural machinery. In general, there has been a low default rate with many loans covering 65% of the value of the asset and backed by personal guarantees.

Such funds are likely to be unregulated by the FCA and may be registered in an offshore location such as the Cayman Islands so will fall outside the Financial Services Compensation Scheme. These funds are unlikely to distribute income, so if income is required it must be taken by selling units in the fund.

Freehold ground rent funds. These provide access to a diversified range of UK residential property freehold ground rents with a view to achieving steady and predictable returns.

Ground rent is the payment made by the lessee of a property to the freeholder of that property. It represents the underlying freehold interest in a property which is subject to a lease for a period of time usually between 99 and 999 years.

Primary healthcare property. This type of investment provides exposure to the commercial property market through a vehicle that is effectively backed by the UK Government with rental income is guaranteed by the NHS.

Multi asset class hedge funds. These will invest in bonds, equities, commodities and foreign exchange contracts. Exposure in each fund will typically be via futures markets so gains can be made in bear markets as well as bull markets.

In holding several as part of a portfolio an investor should aim for a zero coefficient of correlation, so that losses in a period in one fund will hopefully be offset by gains on another fund. The reason for this low correlation is that the investment decision making at some funds will be based on macroeconomic research while at others it will be based on quantitative data, such as value and momentum.

Infrastructure projects. Examples include government accommodation, education, health, transport, utilities and law and order. These projects typically have long term contracts with government or healthcare agencies who commit to pay for agreed services. As such, this investment is designed to provide a predictable income stream with modest capital growth.

While government agencies represent a good credit risk, there is always the possibility of default or the termination of a contract under certain circumstances.

Alexander Fahie is an investment adviser at Prospect Wealth