Bear market will prove the biggest test for Gars and co

John Kenchington

The future of active fund management could be in the hands of a few highly sophisticated investment vehicles that have yet to be tested by a bear market.

I am talking of course about the raft of funds that have sprung up to emulate the success of Standard Life’s Global Absolute Return Strategies (Gars).

It’s clear the market for ‘traditional’ active funds that aim to beat benchmark indices in particular markets is in an irreversible structural decline.

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Amid the increasing focus on the costs of investing many will continue to simply leave their money in passive tracker funds, particularly in sectors such as pensions. Innovations in areas such as smart beta will enable passive-fund providers to expand their product ranges exponentially.

But there will always be things that can’t be replicated cheaply by a tracker fund. This new raft of global absolute return funds is one of them.

The process of deciding how much money to allocate between myriad global asset types dynamically, while drawing upon sophisticated instruments such as derivatives to dampen risk, is a qualitative one.

So for active asset management these funds are important, and the next market crash will reveal whether they really work or not.

They have all shown they can flourish in a bull market. All the popular funds of this type have gained at least 6 per cent in the past year, with the exception of the BlackRock Dynamic Diversified Growth fund’s 3.1 per cent.

In the past six months they are also up healthily, with Standard Life Gars adding 4.1 per cent and Aviva Investors Multi-Strategy Target Return gaining 5.5 per cent, for example.

How are they handling the sharp short-term volatility in the markets recently? Interestingly, many of them are down in the period since May 4.

The Aviva fund has lost 1.4 per cent, Investec Diversified Growth is down 1.3 per cent and Invesco’s Global Targeted Returns is 0.72 lower. Gars has lost 0.68 per cent.

Clearly this is an extremely short period but it could suggest these funds are, at the very least, not invulnerable to market volatility.

Would a profound bond market shock – which looks to be a distinct possibility in the months ahead – translate to disappointment for these funds’ investors?

In January research group Fundhouse claimed that Gars had been too reliant on the bond bull market for returns.

Clearly these funds have the ability to benefit from a bond market crash thanks to their abilities to ‘go short’ certain areas, but your market timing has to be very good to play that game.

If a market shock does expose these funds, as the first breed of ‘absolute return’ funds were six years ago, it would not bode well for the future of active management.

John Kenchington is editor of Investment Adviser