Absolute Return comes to fruition

Equity and bond markets have risen almost without interruption since the financial crisis, so returns have looked anaemic compared to traditional asset classes. However, with many of those asset classes now richly valued, an absolute return approach may be a significant advantage in the future.

So how has the IMA Targeted Absolute Return sector evolved? And does it present a possible solution to the new environment?

The early years of the sector’s existence brought some well-documented reputational problems. Performance was, in many cases, lacklustre, with ‘absolute return’ too often becoming a byword for ‘no return’.

However, the sector’s reputation has been revived with the performance of funds such as the Standard Life Global Absolute Return Strategies (Gars). The IMA Targeted Absolute Return sector was the second best-selling IMA sector last year, with £2.2bn of net retail sales or roughly 10 per cent of all the money coming into the UK retail fund market for the year. The strong flows have continued into 2014.

The sector mainly comprises multi-asset funds, absolute return bond funds and long/short equity funds, though some currency and macro funds also appear. Multi-asset strategies have the lion’s share of the assets, although there is a numeric bias to long/short funds among the sector’s 70 funds.

The Gars and Newton Real Return funds account for approximately £20bn and £8bn respectively of the sector’s £38bn of assets.

The success of Gars has spawned a number of imitators and recent new launches have tended to focus on a similar multi-asset approach, with the Invesco Perpetual Global Targeted Returns and the Aviva Investors Multi-Strategy Target Return both launched by former members of the Gars team.

The long/short equity and absolute return bond funds in the sector have had to wrestle with rising markets. Many have increased their market exposure to keep pace. Research by Financial Express showed that 14 out of 57 funds in the sector with a three-year track record had a correlation of more than 0.71 with the FTSE All-Share over the three years to 30 June.

Oliver Wallin, investment director at Octopus Investments, says the sector remains a tricky one for advisers to negotiate: “Funds self-select for inclusion and do not have to meet specific investment criteria – as the IMA’s own definition puts it, ‘Asset selection is at the discretion of the manager.’ Funds simply have to target a specific level of positive returns over a stated timeframe, which must be less than three years.

“When the available funds have such varied strategies and objectives, and the relative returns may be skewed by the performance of a single dominant fund, investors are likely to have trouble making sense of the choices on offer.”

Matthew Frost, associate director at Henderson, suggests advisers are becoming more nuanced in the way they use funds, using different funds for different economic climates.

Mr Wallin agrees advisers are more willing to switch between absolute return funds when conditions warrant it. For example, equity long/short products were a key beneficiary of the increase in stock dispersion last year. Meanwhile, anecdotally, the popular Newton Real Return and Standard Life Gars funds tend to be used as core funds or natural drawdown products.

Mr Wallin says there have been other improvements in the sector. Funds are becoming more mature and accommodative in the way they treat their investors, offering lower fees, greater transparency and better regulatory structures.

The IMA Targeted Absolute Return sector has improved; now it needs the right markets in which to flourish.

Cherry Reynard is a freelance journalist

Expert view: Absolute return

Matthew Frost, associate director at Henderson, believes knowledge is improving: “Clients looking for absolute return investments understand the make up of the sector better than in its early days. I think this has helped reduce some of the earlier bad press that the sector received as people were confused with some of the funds.”