Opinion  

Absolute return yet to prove itself during short-term shocks

Jake Moeller

Jake Moeller

In the atrophy that has gripped the UK funds industry in the face of the upcoming Brexit referendum, sales of funds within the Investment Association (IA) Targeted Absolute Return (TAR) sector have remained comparatively buoyant.

The sector contains some £59bn of assets as at April 2016, with estimated net inflows of some £2.4bn in the first five months of the year. There are five funds out of a sector of 77 with assets exceeding £1bn as of the end of May.

The growth in the sector has been commensurately reflected in product launches. It was not so long ago that Newton Real Return stood alone for several years, until it was joined in 2004 by a handful of other funds.

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Since 2014, there have been 18 new funds launched into the sector, which is now comprised of 77 portfolios overall.

Absolute return funds generally seek to generate a specified return, say an amount above a rate of interest such as Libor or an inflation metric, over a given period. Often, this period is stated as three years, but it can be more vague: “market cycle” or another loosely defined rolling period.

While sector classification schemes typically allow investors to compare like with like, absolute return can be harder to aggregate.

Interestingly, the IA has seven qualifications to the definition of its TAR sector. It also includes a rolling 12-month monitoring analysis owing to the fact it identifies “a wide expectation among consumers that funds will aim to produce positive returns after 12 months”.

Indeed the 12-month “expectation” is probably a reasonable assumption in reflecting investors’ perceptions – “absolute return” could lead unwary investors into a false sense of security.

The reality is that many of the funds in this classification are market-linked and do not offer a guarantee against market loss in the way that a structured product might.

The varying nature of funds in the sector is further revealed by returns. The best-performing fund in the first four months of the year has returned 6.6 per cent, while the poorest performer has lost 15.3 per cent over the same period. Indeed, only 38 per cent of all the funds in the TAR sector have returned a positive value over this period.

Over the longer term, the figures appear better. Over three years to April 30 2016, 16 per cent of funds in the sector returned a negative amount and over five years to the same date, only 4 per cent of funds have lost money.

This does not mean, though, that investors have benefited from stellar performance against a risk-free rate. Taking the average of the monthly rolling one-year Sharpe ratio (using UK retail prices index plus 3 per cent) over four years to May 2016, only 10 funds in the classification returned a positive Sharpe ratio average.

It might be tempting to turn to funds in this sector when shorter-term macro factors such as Brexit grab the headlines. However, the evidence in this sector suggests that funds here may not be matched to shorter-term time horizons any better than those in other market-exposed sectors.