Ditch absolute return funds after ‘cardinal sin’ loss
Absolute return funds, those that attempt to make money no matter the market conditions, have been extremely popular among cautious investors ever since the financial crisis as people have sought protection from a repeat of history.
But these investments did not live up to expectation in 2018, with the average absolute return fund failing to make money last year, according to data provider FE Analytics.
In a similar way to gold and cash, absolute return funds are supposed to anchor a portfolio otherwise invested in riskier funds. Their job is to make money regardless of whether stock markets rise or fall.
There is no one way that this type of fund aims to achieve this objective. Some use complicated transactions involving markets and currencies, while others are more traditional multi-asset funds. Key, however, is that they are expected to experience low volatility and should rarely lose money – certainly not large amounts in a short period of time.
Absolute return funds are not expected to make as much money when markets are rising (although should still rise) but should come into their own when markets are falling.
Last year, however, when global stocks fell by 3.8pc, the absolute return funds sector lost 2.9pc. Of the 118 funds, just 15 made investors any money in 2018. The best performer, BlackRock Emerging Markets Absolute Alpha, returned 12.3pc, while City Financial Absolute Equity, the worst performer, lost 17.6pc.
Gary Waite, portfolio manager at Walker Crips, a broker, said that the funds had failed to do their one job: “The cardinal sin for an absolute return fund is to lose money when the market is going down. Why hold it if they are just average in all market conditions?”
Many of the managers looking after such investments argue that most funds aim to make a positive return over a three-year period, rather than just one year. Yet over the past three years, during which time global stocks have risen 40.2pc, the sector has returned just 1.5pc on average.
Of 105 funds, 64 have made a positive return over three years. Polar Capital UK Absolute Equity did best, up 57.2pc, while FP Argonaut Absolute Return, the worst performer, lost 23pc over this period.
Despite more than a third of these funds failing to meet their objective, investors continue to buy them.
Mark Dampier of Hargreaves Lansdown said people are seeking funds that can “turn lead into gold”, promising good returns for no risk.
He added that the financial services industry has done its best to create something to meet this demand, but the truth is that it is an impossible goal.
“All the problems in the industry have come from lower-risk, ‘defensive’ funds trying to give clients what they want, which is a 10pc return with instant access and no risk,” he said. “But it’s not available. You are going to go through horrible periods whether you like it or not.”
Rather than buying these funds, which are typically quite expensive and can be very complicated, Mr Dampier said that cautious investors would be better served keeping more of their portfolio in cash.
Or they could take a lesson from the history of stock markets, which shows that over time you are better off staying fully invested in an equity fund, regardless of backdrop. Those looking to invest in this way can find inspiration in Telegraph Money’s list of its 10 favourite defensive funds at telegraph.co.uk/ go/defensive10.