Time for absolute return funds or time to call time on them?

24th May 2013

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With the equity and bond market rallies apparently drawing to a close, the time should be ripe for absolute return funds to show their strengths. In this environment, the flexibility to go long or short a market, or move into different asset classes, should be valuable. The trouble is, in aggregate, the sector has not proved that this flexibility produces strong returns or mitigates risk. Might a changing environment signal better times for the sector asks financial journalist Cherry Reynard.

As a whole, funds within the Absolute return sector have not covered themselves in glory, and they certainly haven’t lived up to their launch hype five years ago. Over five years, only four out of thirty-six sectors have performed worse (both money market sectors, protected and property). Over three years, only the money market sectors have performed worse.

Equally, for funds that were supposed to offer a more even return, avoiding the drawbacks of long-only equity funds, some have offered a roller-coaster ride. The BlackRock UK Absolute Alpha fund, once the poster boy for the sector, is down 3.5% over five years, and 4.3% over three years. The average fund in the UK All Companies sector is up 35.3% and 53.7% over the same time periods. It has also been a graveyard for some skilled managers, denting the reputations of, for example, Philip Gibbs at Jupiter.

Yet, the last set of IMA statistics showed that the Absolute Return sector was the top seller in March as trade paper Investment Week reports. Equally, Morningstar’s summary of asset flows in Europe shows that allocation funds raked in €8.8 billion in March and the top selling long-term fund was absolute return in nature – the Templeton Global Total Return Fund. This suggests appetite for the approach is strong among investors.

Recently, in the Financial Times, the Ignis Asset Management’s chief investment officer Chris Fellingham said that he believed absolute return funds would be the key growth sector for the group:

“In my lifetime, we’ve never seen such manipulated markets as we currently see, where central banks are moving the risk-free rates to make other asset classes attractive,” he says. “The environment is pretty difficult. Prices are pretty damn false. And that makes absolute return investing pretty attractive.” He adds: “If you can say to people, I’m going to deliver a 5, 6 or 7 per cent return, that should be attractive in this sort of environment.”

But the sector’s only real traction to date has been into the asset allocation funds. The majority of the flows have gone into the Standard Life GARS and Newton Real Return funds, which are now £16.7bn and £7.82bn in size respectively. The  poorer performance of the BlackRock UK Absolute Alpha fund, which represented a ‘toe in the water’ into absolute return investing for many investors has damaged interest in the long/short equity funds in the sector, even though many of the top performers over three years are funds of this type. Paul Marriage’s Cazenove Absolute UK Dynamic fund, which has had excellent performance over the last three years, remains a relative minnow at £293m. The Odey UK Absolute Return fund, which sits at the top of the sector over one and three years, is £555m.

Can the flows into the sector broaden and diversify? Patrick Connolly, certified financial planner at Chase de Vere, only recommends the Newton and Standard Life funds in the group’s client portfolios: ” In an environment where equity markets have risen strongly and many parts of fixed interest seem over-priced, there should be an opportunity for Absolute Return funds to demonstrate they can have an important role to play in investment portfolios. However, the vast majority of Absolute Return funds and the sector as a whole hasn’t yet managed to earn the trust required to step in, even at this time when they could be most needed.”

Among the fixed income funds in the sector, performance has been steady. The Schroder Absolute Return bond fund stands out as having delivered long-term consistent performance. Threadneedle’s Absolute Return bond fund is also a strong longer-term performer. There are also relatively new funds from BlackRock and Alliance Trust, which may win plaudits from investors. This type of fund may attract more attention if the bond rally finally fails.

The problem for the sector as it stands is that investors have seen a number of funds perform poorly and the remaining funds do not have a sufficiently long track record to convince investors that performance is sustainable. Nevertheless, if the Odey and Cazenove funds on the equity side, and the Schroder and Threadneedle funds on the fixed income side can keep up their current run of performance, the environment may just be about to turn in their favour.

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