As volatility in global stock markets starts to pick up, funds that promise capital preservation could become more popular – but investors should make sure they understand the strategy of a fund before parting with their cash.
Investors hold a hefty £79.5 billion in Targeted Absolute Return funds, according to most recent data from trade body the Investment Association. It’s the third largest sector by assets under management.
These funds promise to deliver a positive return over a set rolling period in any market conditions. It’s undoubtedly an attractive strategy for cautious investors, particularly at times of uncertainty.
Yet many of the funds have failed to deliver. Seven of 49 Targeted Absolute Return funds are in the red over a five-year period. The weakest among them is the Threadneedle Absolute Return Bond fund, which is down 12.2%.
Clearly some investors are feeling disappointed – in April alone, some £131.8 million poured out of the sector, the third largest outflow by sector in the month.
But this group is a mixed bag whose constituents are notoriously difficult to compare. At the other end of the spectrum, City Financial Absolute Equity has produced a meaty return of 49.6% over five years and 7IM Real Return 34%.
Patrick Thomas, investment manager at Canaccord Genuity, says: “Performance of this category has been generally horrific relative to conventional long-only funds over the past five years, although some of the funds which have been around for longer have done well.
“This is a very wide category of funds and there are significant differences in the philosophies of individual managers. Investors need a very clear plan for how an absolute return fund fits with their objectives.”
Fabrizio Quirighetti is portfolio manager on the Oyster Absolute Return fund, which launched in April 2008. It has managed to produce a positive return in nine years out of the 10 it has existed. In 2015 it fell 0.5%.
Quirighetti says: “Given today’s low, albeit rising, yield environment, investors are struggling to find valid alternatives to cash or bonds but are also wary of volatility and overstretched equity prices in the stock market. Absolute return funds can be a solution.”
His fund, which has returned 14.8% over the past five years, has a large exposure to fixed income and uses equities and currencies to help keep volatility low and provide diversification. Quirighetti says being flexible is key to success in this mandate.
Top Rated Absolute Return Funds
Just one fund in the Targeted Absolute Return sector has a Silver Morningstar Analyst Rating. Newton Real Return was one of the first multi-asset funds with a return target to launch and has amassed almost £10 billion in assets since its inception in 1993.
The fund has returned 10.5% over the past five years and Morningstar analyst Randal Goldsmith says it’s a “strong choice” for investors seeking capital preservation. Much of the fund’s return has come from stock selection, while asset allocation and the use of derivatives have helped keep volatility low.
Goldsmith adds: “The fund stands out for the experience of its manager in multi-asset target return investing and the consistency and success of the approach.”
A further five funds in the sector have a Bronze rating. Of these, the top performer is BlackRock UK Absolute Alpha, which has returned 23.5% over five years.
But the funds of this sector are far more difficult to compare than many others – the way each measures its absolute return and the aims they have vary widely, with many using complex financial instruments and derivatives to meet their goals. It can mean that some are riskier than they might first appear.
The choice between a 50% and a 10.5% return might seem like a no-brainer but investors should bear in mind how a fund is achieving its returns. Cautious investors may prefer a steadier approach with less equity exposure, for example.
The bulk of funds aim to keep volatility low and produce a modest return during bull markets and provide capital preservation when markets are more volatile. Those which have managed to make significant returns are likely to be taking a more aggressive approach.
Thomas warns that those which have thrived in recent years could lag in a bear market environment, which makes it vital that investors do their homework rather than making a decision based on past performance.
While it may seem as though the majority is underperforming by comparison, it may just mean they are simply doing the job they have laid out.
Thomas adds: “There are some excellent managers across these funds but the big problem is the complexity of many of the underlying strategies. I would tend to avoid those which are more opaque and those with shorter track records.”
