Tread carefully with funds that are not for absolute beginners
ABSOLUTE RETURN funds aim to generate assured profit regardless of economic conditions over a specific period, along with safeguards which are missing with traditional equity holdings. They therefore offer a helpful source of diversification.
Many savers look for capital protection in their portfolios. This has been the calling card of absolute return (AR) funds. At a time when stock markets are volatile, combined with fixed interest assets looking expensive, such collectives carry good appeal.
These key factors were reflected in AR funds becoming the best selling class in both 2015 and 2016. However, sentiment has changed and in the past year, such funds have seen outflows of around £50bn. The largest victim has been the Global Absolute Return Strategies fund run by Standard Life Investments, which has seen almost £10bn withdrawn in the last year.
If considering an AR fund, it is important to understand what it does, how much it charges and how it has performed. There may be ‘safer’ collectives, notably bond funds, or you may feel that taking very low risk reduces opportunity too far. If you do not have an experienced financial eye, it would be better to take the helping hand of a knowledgeable wealth manager or consult an experienced independent financial adviser.
The funds in this sector take vastly different approaches. There are two basic routes to achieve the same goal:
■ Invest in different assets and diverse parts of the market.
■ Use derivatives to sell an investment the fund does not own which enables the manager to profit from falling as well as rising prices, just like a hedge fund.
With such strategic variation, it is not surprising that performances differ significantly. In the last decade, AR collectives have had to contend with an upward stock market and have lagged behind mainstream equity funds.
In addition, there has been the challenge of trying to anticipate the actions of central banks, governments and how markets will react to new policies.
Despite this, “AR funds have a place in any investor’s portfolio as they offer some capital protection which when markets are rising investors do not want but if markets fall they will be wishing they had exposure”, says Adrian Lowcock, chartered wealth manager at adviser Willis Owen.
He feels no more than 10 per cent should be placed in defensive assets as markets rise on average and having too much such exposure would lead to a drag on performance.
Over the past year, the top performing AR fund gained 20.5 per cent but the worst performer lost 23.5 per cent.
“Too many AR funds are too closely linked to stock markets. So when markets fall, they fall also,” warns Kelly Kirby, chartered financial planner at Chase de Vere, part of the Swiss Life Group.
“We have a high level of scepticism in using AR funds in portfolios,” admits Adam Martell, investment manager of Charles Stanley in Leeds. He says this stems from a combination of over-complexity, high manager charges and underwhelming returns.
Charles Stanley require daily dealing for any fund selected and to be compliant with the UCITS regulations, which means hedge funds with their weekly or even quarterly lock-ups are excluded. It examines the likelihood of performance targets being met with low correlations to major asset classes and seeks to avoid significant one-way risks.
In 2018, just 11 AR funds returned a profit while a staggering 89 collectives lost money with 31 per cent losing five or more per cent. With stock markets showing firm gains this year, AR funds have also achieved more success. However, the elegiac truth is that 17 funds have still lost money with the BMO Global Equity Market Neutral fund loosing an amazing 22.7 per cent.
Such disappointing returns do not support the theory that AR funds will produce a positive return in all environments, combined with providing protection, alongside shares, in an investment portfolio. The otiose marketing has turned out to be false in too many cases with narcoleptic managers not up to the job.
Expect charges to be higher than conventional funds as quite often the investments made are multi-layered, such as purchasing a specialist fund which in turn has multiple holdings.
Yet, Kirby says: “It is difficult to justify some of the high fees which are charged.”
“It is vital to look under the bonnet and take time to understand the likely drivers of return,” says Martell. Looking back at previous episodes of market stress, he says Investec’s Diversified Income fund has coped very well, relative to both its diversity and income peers as well as delivering a positive total return.
Martell feels that should equity markets fall, this fund will outperform and maintain a reasonable level of income. Since inception, it has returned four to five per cent annually.
Newton Real Return is Martell’s other choice. Its mandate is to seek a minimum return of cash plus four per cent annually over five years before fees.
A relatively unconstrained and flexible approach is taken to manage the portfolio. As a fund house, Newton has experience of managing this type of lower risk combined with a proven track record.
Lowcock also likes Newton Real Return whose manager, Suzanne Hutchins, makes capital protection the first priority. There is a low turnover of the bonds and shares held. His other tip is Henderson UK Absolute
Return with seasoned managers Ben Wallace and Luke Newman at the helm.
They aim to add value through long-term fundamental research and via shorter-term trading opportunities. The duo can also invest in non-UK stocks whose value is limited to 40 per cent of the net asset value.
Darius McDermott, of Chelsea Financial Services, looks for funds with lower target returns in the range of an annual three to 10 per cent but also collectives that take lower risk to achieve them.
He recommends three: Church House Tenax Absolute Return Strategies (which is multi-asset but cautious), Smith & Williamson Enterprise (only into UK equities and is riskier) and Twentyfour Absolute Return Credit (which goes for bonds that are due to mature relatively soon, decreasing the risk that the company will be unable to pay).
Kirby tips four AR funds: BNY Mellon Real Return, BNY Mellon
Global Dynamic Bond, Invesco Global Targeted Returns and SVS Church House Tenax Absolute Return Strategies.
Finally, remember that AR funds are not risk-free. There are hidden risks and a good wealth manager or IFA will match an AR fund to your level of risk tolerance.
Be prepared to switch fund allegiance when signs of underperformance occur.
■ Conal Gregory is AIC Regional Journalist of the Year.