4th March 2014
Investment journalist Cherry Reynard examines the Absolute Targeted Return fund sector and whether the recent name change has made a difference.
This sector was previously the plain old ‘Absolute Return’ sector, but the fund manager’s trade body the Investment Management Association decided that investors could be misled into believing the ‘absolute return’ was a guarantee. It isn’t. Instead, as the new name suggests, funds in the Absolute Targeted Return sector, target a return in excess of cash or inflation in all market conditions but they can’t guarantee it.
This differs from standard stock market funds, which will usually aim to beat an index, such as the FTSE All Share. Most absolute return funds will aim to beat their benchmark on a three year rolling basis, so investors may see a loss of capital in individual calendar years.
The range of fund strategies within sector?
Absolute Targeted Return fund managers will employ one of three main strategies to achieve their goals: the first is a long/short equity strategy. This is where a manager balances a conventional ‘long’ portfolio of shares, with a portfolio of ‘short’ positions. By employing ‘short’ positions through the use of derivatives, the manager can profit from falling share prices. For the long portfolio, the manager will look for those companies that are likely to see an improvement in their business, and for the short portfolio, they will aim to uncover those companies likely to do badly. In theory, the result should be a portfolio that can deliver growth in a variety of market conditions. In practice, it is dependent on the fund manager’s skill in selecting the right – and wrong – companies.
The second strategy is similar, but instead of investing in the stock market, the fund manager will invest in the bond market. They can take long and short positions across corporate and government bonds, depending on where they see value. This type of strategy has come into its own more recently as investors have sought to retain exposure to fixed income markets, but protect themselves against rising interest rates.
The final strategy – and by far the most popular – is a multi-asset approach. This is the strategy employed by the largest funds in the sector, such as the Standard Life Global Absolute Return Strategies and Newton Real Return funds. These funds will blend different asset classes together, looking across bonds, equities, currencies and other securities for the best mix of risk and rewards. At any one time, a fund may be exposed to global pharmaceutical companies, having significant positions in the US dollar and be invested in Brazilian government bonds. These strategies require big teams, and therefore tend to be offer by the larger asset management companies.
Over the past five years, the average fund in the Targeted Absolute Return sector has grown by 25.2% (to 28th February). Only a handful of funds have a five year track record, however, and the average over three years is 9.2%. This compares to average growth from the UK All Companies sector of 37.9% over three years and 134.7% over five years.
Top of the sector over three years is the CF Odey Absolute Return fund, managed by veteran stock-picker Crispin Odey. The Argonaut Absolute Return and City Financial UK Equity funds have also performed well. The best and worst funds have tended to be long/short equity funds, depending on whether the manager has selected the right companies on both the long and short sides.
The multi-asset funds have proved more consistent, sitting in the upper third of the sector table. Bond funds have been relatively dull, but have generally preserved capital. They may come into their own relative to other fixed income funds as interest rates rise.
Across the sector, ten out of 67 funds have not preserved capital over one year, and five out of 58 over three years.
When does it perform well/badly?
In theory, absolute return funds should provide a consistent return in all market environments. That means they are likely to underperform a fast-rising stock market, but will protect investors’ capital at a time of stock market weakness. In practice, this hasn’t always been the case and some funds have proved extremely market sensitive. The performance characteristics will vary with the type of fund chosen.
What sort of investor does it suit?
An absolute return fund will suit those investors who would prefer to smooth out some of the volatility associated with stock markets, and are happy to miss out on some of the strongest gains for a more consistent return. Absolute Return funds can act as an important diversifier in a portfolio, helping to balance out high stock or bond market exposure. Some – particularly the multi-asset funds – have proved to have only low correlation with conventional securities markets.
How much of a portfolio for low/mid/high risk investor?
There are those who believe that all investments should be managed using an absolute return approach. If an absolute return fund works properly, it should be the perfect investment delivering consistent returns year after year. However, very few funds have done that. As a result, most discretionary fund managers only have a weighting of between 10-20% of their portfolios in this type of fund. They may introduce higher exposure at times of market stress.
Top 10 by performance (3 year) – Targeted Absolute Return sector
CF Odey Absolute Return
FP Argonaut Absolute Return
City Financial UK Equity
Cazenove Absolute UK Dynamic
L&G UK Absolute Return
Henderson European Absolute Return
Old Mutual Global Equity Absolute Return
RWC US Absolute Alpha
Cazenove UK Absolute Target
BlackRock European Absolute Alpha
Questions for investors to ask
Where is the manager invested – bonds, equities or across different asset classes?
What are the risk controls on the fund?
How close has fund performance been to conventional equity and bond markets?
When does this fund tend to perform best (rising, falling equity markets, for example)?
What are the underlying themes in the portfolio?
Adviser opinions and fund suggestions
Gavin Haynes, investment director, Whitechurch Securities
There are now 70 funds in the Targeted Absolute Return sector, but the disparity of funds within this sector makes it very hard to compare performance. There are significant differences in risk/reward profile of absolute return funds. When looking at this sector it is important to analyse at each fund on its own merits and have a good understanding where the funds will invest and what strategies will be employed.
Stand out funds in the sector include the Standard Life GARS fund which follows a multi-asset approach and has been exceptionally successful in grinding out returns across market cycles. Such has been the popularity of this fund, it is now £20 billion in size. Blackrock European Absolute Alpha is another fund that has produced solid, steady returns. This is a European equity focused strategy that has a relatively low risk profile, taking a market neutral approach,
David Coombs, head of multi-asset investments at Rathbone Unit Trust Management
This is very good environment for long/short equity funds and we have been adding money to this type of strategy recently. At the moment we hold the Henderson UK Absolute Return fund, managed by Ben Wallace, but we are working on finding more funds in this area.