InvestmentsJul 11 2016

Best to invest in a plodder than a fad

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Best to invest in a plodder than a fad

These funds vary in the techniques they use to achieve their objectives and in the level of risk and return the manager targets, which in turn leads to a wide spread of returns from the sector’s constituents.

As Fergus McCarthy, head of UK & Ireland intermediary distribution at BNY Mellon, reveals: “There is a perception among investors that these funds should be safe havens in times of volatility.

“However, an analysis of the returns from some of the best-selling absolute return funds year to date reveals a performance differential between the best- and the worst-performing funds of nearly 15 percentage points (-8 to 7 per cent), so advisers have to do their research to ensure they get the outcome they want for their clients.

“This choice is further complicated for advisers by deciding which type of absolute return fund they want to use, with terms like long/short, global macro and market neutral being used readily as descriptors.”

Comparing absolute return funds: Expert Views

Jake Moeller, head of UK and Ireland research at Thomson Reuters Lipper, says:

“This sector is one of the most heterogeneous sectors in the UK consisting of funds with equity, alternative, long/short, bond and mixed-asset mandates, to name a few. The best way for investors to compare funds is to ensure they are comparing like with like. Sometimes the clue is in the name – for example the Royal London Absolute Return Government Bond fund should not blindly be compared with the Polar Capital UK Absolute Equity fund. Investors should look at volatility outcomes and think about comparing these funds by high-, medium- or low-risk buckets and look at drawdown. This can paint a picture of composition without having to trawl through each individual portfolio.”

Adrian Lowcock, head of investing at Axa Wealth, applies a similar method:

“The best approach is to identify the types of funds you want and then pick out each fund which ticks that box and compare this sub-set of funds. It is a laborious job but one that is essential if you are to get the right type of fund for your portfolio. When comparing performance, consider the fund’s objectives and take a long look at downside protection as this is a big part of many of these funds’ objectives. Consistency of performance is also an important consideration.”

Adrian Lowcock, head of investing at Axa Wealth, suggests investors approach choosing an absolute return fund by deciding what it is they are looking to achieve or by considering what is missing in their portfolio.

“Are you looking to add a bit of capital preservation to your investments or perhaps concerned about bond prices and want more flexibility in how returns are generated from that asset class?” he asks. “Once you have decided what you want, you need to decide what type of risk you are willing to take with it. Absolute return funds are a hotchpotch of different objectives and strategies.”

In this case, past performance can be a useful indicator and can help investors understand how an absolute return fund performs in different market conditions. David Bint, multi-asset investment specialist at Standard Life Investments, advises investors to pay particular attention to how absolute return funds have performed during substantial market downturns.

“If investors are buying them because they think they are more secure, they should look at how they’ve behaved in the past,” he says. “These funds will often go down in market turbulence as well, they just don’t go down as much as the typical profile. [Investors] should think about the risk and how much money they could lose, because absolute return does not mean it will never make a loss.”

Mr Bint continues: “They should also pay attention to the fee they’re going to be charged; the longevity of track record; the resources the investment management firm concerned puts behind the strategy; and the stability of the management process.”

KEY FIGURES

103

Number of funds in the IA Targeted Absolute Return sector, according to FE Analytics

15pp

The performance differential between some of the best- and worst-selling absolute return funds, year to date

Darius McDermott, managing director at FundCalibre, agrees: “There are two very important considerations: look at the historic volatility; and look at the drawdown.

“One of the reasons people invest in an absolute return fund is to have some protection when markets fall – an insurance policy, if you like. The biggest sin of this type of fund would be to be down as much as the market. And look at its correlation to equities and bonds.”

Distinguishing between those absolute return funds that are genuinely doing what they set out to achieve and those simply following the direction of the market is key to choosing the right fund for a portfolio.

Rory Maguire, managing director at Fundhouse, cautions: “Be aware of funds that do well in a bull market, for example, and be drawn to those with modest returns in rising markets. We would also aim to find funds that have been tested in tough market environments – again, this separates out the faddy funds from the long-term plodders that we like. Being sceptical of new launches that appear to solve a current need would be a good rule of thumb.”

Fund Picks: Expert View

Darius McDermott, managing director at FundCalibre, selects his three favourite funds, one each from three categories of absolute return fund – long/short equity; market neutral long/short equity; and a multi-strategy or Gars-style product:

1) Henderson UK Absolute Return

2) Old Mutual Global Equity Absolute Return

3) Church House Tenax Absolute Return Strategies

Mr Maguire ultimately believes absolute return funds are not the answer to all savings needs, although he acknowledges they do have a role to play.

“For clients with long time horizons, equities should be where they allocate most capital and we would only consider an absolute return fund for the sub-allocation of their savings pot that used to be set aside for bonds.”

Ellie Duncan is deputy features editor at Investment Adviser