Fund Selector: No one strategy is a silver bullet

Fund Selector: No one strategy is a silver bullet

It has been interesting to observe the positive fund flows into targeted absolute return funds this year.

Their popularity is not surprising given Brexit uncertainty, but I would argue it’s as much a result of other asset classes looking less appealing, and the requirement to diversify portfolios, rather than widespread enthusiasm for these funds in particular.

Brexit concerns aside, many industry professionals are now uneasy that the summer of high asset class correlation and low volatility is the calm before the autumn storm. I share their worries. What goes up together often goes back down in tandem, too.

Article continues after advert

Absolute return funds do, on the surface, offer a potential solution. If diversification is hard to achieve in the traditional sense through equities and bonds, then why not use them as an uncorrelated component of a portfolio?

The main competing asset classes are also looking less appealing. Defensive equities are expensive, the investment-grade bond market is looking fully priced, while opting for cash is going to earn virtually nothing – where else can you park your lower risk portfolio allocation and expect a decent return? Blending absolute return strategies certainly sounds like a viable option.

But do absolute return funds actually offer genuine diversification and returns?

On the diversification front, it depends. The sector is a mishmash of funds taking a variety of investment approaches and levels of risk. There are conservative funds looking to eke out consistent but modest returns, and swashbuckling mandates giving managers the ability to take on more market risk.

Clearly the latter can, at least at times, exhibit a high level of correlation to other assets – often equities – and these funds should, perhaps, be better considered as part of a well-rounded equity allocation, instead of sitting in a basket of ‘alternatives’ whose role includes diversification.

Then there are those relying largely on fund manager alpha, which is ephemeral in nature. With relatively little positive effect from market exposure, or reinvesting dividend income, many such funds have struggled to perform, or feel the need to charge off-putting performance-related fees. These strategies could offer diversification but, in my view, the number of managers who can run these funds successfully is much smaller than in the long-only world.

That leaves the multi-strategy funds, such as Standard Life’s Gars. That Gars has struggled this year is not a massive issue. Bad as well as good years should be expected, and as long as the latter outweigh the former, and there are not significant drawdowns, then the fund has done its job.

However, it does illustrate that the product is only is good as the ideas that go into it, and getting the blend of these right consistently is no easy task, especially in an unpredictable world where the actions of central banks are key to determining investment returns.