Absolute return investments have been one of the more controversial and challenged areas of the market. They came under scrutiny after many funds delivered materially negative returns during the financial crisis and again during the market turmoil in summer of 2011, therefore failing to deliver on their promise to generate steady and positive returns with lower volatility in all market conditions.
Many funds continue to struggle, but this does not mean it is an area bereft of opportunity
In addressing this, the Investment Association (IA) undertook a review of the sector in February 2013 and subsequently announced a change in the name of the sector to ‘Targeted Absolute Return’, in order to clarify that a positive return was a target rather than a guarantee. Despite these changes, expectations of how absolute return funds perform are often misunderstood by investors.
The IA Targeted Absolute Return sector remains home to a hugely diverse range of strategies investing across different asset classes and geographies and with varying risk characteristics, performance objectives. Following a similar review to that of the IA’s, Morningstar removed the absolute return category in 2011 and replaced it with more granular sub-categories such as long/short, market neutral or multistrategy, and across different investment geographies. While we believe this method will facilitate performance comparisons that are more meaningful, and as such more helpful to investors, the funds remain somewhat heterogeneous.
The performance disparity between strategies has been evident during the recent volatile market environment. Indeed, funds which incorporate more directionality such as the Henderson UK Absolute Return fund, have performed better over last year than strategies which use a market neutral approach to deliver a relatively stable return profile that is modestly ahead of cash.
This was evidenced by the Absolute Insight Equity Market Neutral fund which delivered stable and low positive absolute returns over 2014. However, investors should be aware that the outcome of the former comes with higher volatility and potential for more meaningful capital losses. The appropriateness of each strategy will, therefore, depend upon an investor’s willingness to accept the potential for larger drawdowns in return for a potentially higher return over cash.
An obvious consequence of today’s markets, where macroeconomic uncertainty continues to dominate and where volatility is expected to increase, has been a renewed interest in absolute return funds. Many investors sought refuge in these funds, attracted by the prospect of steady and positive returns with lower volatility. The appeal for the sector has been further supported by the current low/negative bond yields.
Indeed, 2014 saw increasing inflows in the sector, registering record inflows during the market sell-off from the start of September through to the middle of October.
While we acknowledge that many funds continue to struggle to deliver on their objective, this does not mean it is an area bereft of opportunity. There are attractive propositions which have delivered on their objectives over short and long-term periods, generating positive returns in both rising and downturn markets.
3 Funds That We Highly Regard
The Absolute Insight Equity Market Neutral fund has a Morningstar Analyst Rating of Bronze and follows a market neutral approach. This offering is managed by an outstanding team of four managers, led by Andrew Cawker, three of whom have worked together since Insight founded its absolute return capability in May 2005. The management team seeks to minimise the fund’s sensitivity to the direction of equity markets by constructing a diversified portfolio of pair trades through primarily a bottom-up approach.
The emphasis is on developing positive and negative stock ideas and identifying the market risks that apply to each investment, to be hedged appropriately. The team’s disciplined process has helped the fund deliver a very consistent and positive return profile over the medium term. Investors should be aware that such approach will only deliver modest performance especially in the current low interest rate environment.
The Henderson UK Absolute Return fund is Bronze rated and is run by Luke Wallace and Ben Newman, who are experienced hedge fund managers. They aim to generate positive returns by taking long and short positions using detailed company analysis that focuses on stocks that exhibit different earnings expectations to the market, while also being mindful of broader market conditions. In practice, the portfolio is divided between core and tactical holdings with the former accounting currently for around 40% of the assets.
The managers have proven their ability to navigate the fund successfully through different market environments and we remain confident that they will continue to deliver positive returns through their disciplined and risk aware approach.
Within the Morningstar Multistrategy category, which has recently seen the highest interest from investors in 2014, the Bronze rated Newton Real Return fund is a solid offering. The fund is managed by a highly experienced manager, Iain Stewart, who has worked at Newton for more than 20 years, specialising in managing multi-assets funds.
The portfolio has a flexible mandate and can invest across the asset-class spectrum, with both derivative and hedging strategies used to reduce risk and deliver positive returns. The focus is on capital preservation and generating positive returns over the long-term and this objective has resulted in a net long bias, which can make the fund vulnerable to negative returns in falling markets. This was evident in 2011 when the hedges and capital preservation strategies were not sufficient to offset the defensive stance taken by the manager since 2008. That said, the fund’s long-term track record is strong and has delivered on its long-term objective, supported by the manager’s experience and flexible approach to investing.
A version of this article previously appeared in Professional Adviser magazine
