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 per cent.
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 per cent from peak to trough – reveals a number of consistent winners which helped protect investors.
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 per cent 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 per cent and 6 per cent 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."
Mr Bateman prefers strategic bond funds to other alternatives. He says: "They can make tactical calls and that is more important than ever now, given the outlook for interest rates."
Tim Cockerill, investment director at Rowan Dartington, agrees that strategic bond funds could be an option for investors, but warns many types of fixed income are expensive at present.
"You would get some protection from fixed income if we did see a correction later this year, for example, but the asset class is not cheap at the moment," he says.
Cash vs property
If not bond funds where should investors look? For many the classic option has been cash. But with cash accounts paying virtually zero – and certainly less than inflation – investors are taking a gamble with them because of the lack of returns on offer.
After all, no one knows when markets are going to fall, and being in cash can be very painful for investors if markets keep rising.
Of course it does do the job. Mr Cockerill says cash will work if markets fall far enough; a very low positive return from cash would be far better than a 10 per cent loss from equities.
But Mr Bateman says because cash is paying so little at the moment it should only be a small allocation of any investor's portfolio, especially as most already have exposure to the asset class through bank accounts or cash Isas.
Instead, Mr Cockerill prefers funds such as the L&G UK Property trust which can provide diversification because it buys and holds actual properties around the UK, rather than equities. The funds produce positive returns in their own right if equity markets do not fall, benefiting from gains in the value of the properties they hold, as well as from any income the assets produce.
The L&G UK Property fund has returned 9.7 per cent over the last year. That's lower than the average UK equity fund return of 15.6 per cent, but Mr Cockerill says it will provide a lot of downside protection if markets do correct.
"Property funds look quite attractive," he says. "They should be more immune to a correction, and unlike the crisis of 2008 when equities tumbled by nearly half and property funds were similarly impacted, valuations are not as extreme in commercial property this time."
Investors can also turn to those property funds which buy property equities. Mr Bateman says although they invest in equities, the funds do not act in the same way as mainstream equities.
"If investors are worried about a correction, these funds do not typically fall as much, and you still get upside participation," he says.
Ben Gutteridge, head of fund research at wealth manager Brewin Dolphin, says commercial property funds are an option for those nervous about market valuations, but he prefers to buy the largest listed property stocks in the market instead.
He says British Land and Land Securities, two of the country's largest real estate investment trusts, are less correlated to equity markets than other listed companies.
During the last equity market correction in 2012, for example, British Land's share price fell by around half that of the FTSE All Share.
Mr Gutteridge says that diversification – coupled with liquidity in the stocks compared to many property funds – makes them a winning combination for investors concerned about market valuations.
"We would probably go for an open-ended option, like British Land or Land Securities, especially as the companies also have higher cash weightings than most other listed companies, providing a second layer of protection," he says.
Seen as the classic safe haven in times of trouble, gold has been one asset class to avoid since hitting its peak in 2011. From a high of more than $1,900 (£1,124) it has tumbled to as low as $1,200 – a loss of nearly 40 per cent in under three years.
It remains near its multi-year low, trading at just $1,300 currently. Gold definitely remains an option, especially as it is still around a third below its previous peak, but buying gold ahead of a correction is a risky strategy.
Physical gold bought via an ETF or tracker fund provides nothing by way of a dividend, and since timing a correction is impossible, putting large chunks of your portfolio in gold can expose you to a lot of volatility.
Darius McDermott, managing director of Chelsea Financial Services, says: "Gold is deemed a safe haven, but it is also volatile. Physical gold can sell-off just as violently as other assets."
Mr Bateman is also cynical about the effectiveness of gold as a hedge. "There are so many speculators out there which make it risky, and gold is typically a 'hot money' trade driven by desire rather than fundamentals."
Gold funds – which buy the shares of gold or precious metal mining companies – can provide more by way of upside than simply buying a tracker, but they provide very little diversification from underlying equity markets. FE Trustnet data reveals there are no gold funds among the top performers during the last three UK market corrections, and Mr McDermott says they do not protect investors during sell-offs.
"These funds do not give you the exposure you want if markets fall, especially when you consider how volatile mining shares are," he said.
Perhaps the best approach is to pick a variety of alternatives. Specialist funds which buy a range of different investments can provide all-round diversification for consumers worried about a correction but unsure where to hide.
There is also a range of absolute return funds available, which strive to make a positive return in all market conditions by being able to benefit from both rising and falling equities, rather than just those which go up.
While the majority of these funds have famously failed to deliver a positive return when equity markets do fall, FE Trustnet data shows the average fund has fallen less than the market itself during the last three corrections.
There are even a few which consistently outperformed. The CF Eclectica Absolute Macro fund and the TM Cartesian UK Absolute Alpha fund both made positive returns in two of the last three sell-offs.
Some cash rich equities around the globe can even offer protection if markets sell off. Apple, for example, is a company with huge reserves of cash on its balance sheet, which would likely lessen the impact of a sell-off on its share price.
Mr Cockerill says a combination of many different strategies would likely suit investors best. "Ultimately end investors have to decide if they think the market is overvalued, and if they think it is, then my approach would be to consider all of these different asset classes."Reuse content