Pandemic proves fallacy of absolute returns

For the moment, investors are reeling from the slump in global stock markets.

Where can we find shelter in the financial storm? As if the 29 per cent plunge in the FTSE-100 over the past month – and a 32 per cent slump since mid-january – was not alarming enough – perhaps the greatest trauma has been felt by investors in so-called absolute return funds – the very vehicles intended to protect investors from precipitate crashes such as the one now experienced.

It has been impossible to escape the worst shock to global economies and markets in decades. This is an epochal crisis which is re-writing history.

Almost all Europe is now in lockdown, with tens of millions urged to isolate and stay indoors, international airline travel has been brought to a near standstill and large carriers facing bankruptcy, city centres are deserted and literally tens of thousands of business are facing collapse: we are heading for one of the most painful and severe recessions in modern history – and growing concern that there may be no sharp recovery for the foreseeable future.

Coronavirus is proving the blackest of black swans – a shock, unforeseen global event for which there is at present no panacea or immunity. The hope is that its spread will slow in time – as it is apparently doing in China.

Hopefully, central bank intervention and government financial measures should prove vital in helping to cushion the consequences in the weeks and months ahead.

For the moment investors are reeling from the slump in global stock markets. It is not just that diversification has proved of little effect, but that so-called defensive funds and trusts have tumbled along with others. Over the past ten years absolute return funds were heavily promoted on claims that they could protect investors savings from stock market crashes. Many promised a positive return whatever the general setbacks in markets.

In the vanguard of all of these was Standard Life’s Global Absolute Return Strategies fund (GARS) which pulled in some £13 billion at its peak of popularity. Few financial advisers failed to include it in client portfolios and they came to be regarded as key pillars of portfolio building.

The fund employs more than 40 analysts using complex hedge strategies.

But it has been badly hit, values have toppled, and a net £7.6 billion has been pulled by savers over the past 13 months, leaving it with just £4.3 billion under management.

But GARS is far from alone. All told, a record £26 billion is estimated to have been pulled from absolute return funds – which aimed to deliver “positive return in any market conditions”.

Of 25 funds listed in the Investment Association’s targeted absolute return sector, 14 have fallen by more than 10 per cent over the past year and all 25 have fallen over a five-year period. Prominent casualties include BMO Global Equity Market Neutral (down by 24.7 per cent over the past 12 months), Jupiter Absolute Return (down 14 per cent) and Polar Capital Absolute Equity (down 12.7 per cent).

Says Interactive Investor, one of the UK’S largest DIY investment platforms, “The sector overall has not convinced investors about its value in any market environment. The funds are promoted to cautious savers who want some protection in their portfolios, but the managers often use complex hedging strategies that very few understand.”

And Sanlam’s Mike Pinggera, who manages the group’s multi-asset fund, is more blunt: “Making money in all environments”, he says, “is a fantasy”.

UK index-tracker funds have handed investors some of the heaviest losses in a week that saw the FTSE-100 suffer its worst falls since Black Monday on October 20, 1987. Gary Jackson, editor of the Trustnet website, ran the numbers on the Investment Association’s UK All Companies, UK Equity Income and UK Smaller Companies sectors to see which funds were hit hardest.

Several passive funds came top of the list – after all, they are designed to mirror any gains or losses across the stock market as a whole.

Vanguard FTSE UK Equity Income Index and Vanguard FTSE 100 Index Unit Trust made the biggest losses, followed by the £422.9m ASI UK Unconstrained Equity fund – an active strategy. But only these three funds made a higher loss than the 10.43 per cent fall seen in the wider FTSE All Share index.

Other passives are towards the top of the list, but they made a lower loss than the FTSE 100 and the FTSE All-share, as did most active fund managers.

Prominent trusts to show resilience so far are (who would have thought it?) J P Morgan China Growth and Income, still up 18.6 per cent over the past twelve months, Ecofin Global Utilities (up 15.8 per cent) and the £492 million Standard Life UK Smaller Companies Trust. Its manager Harry Nimmo has featured regularly among the top performers and even after last week’s stock market battering, the trust is still sporting a 13.3 per cent gain over the past 12 months.

Hold on to quality would seem to be the moral here – and stay in cash and gilts for now. This may prove a long and devastating tsunami.