Absolute Return funds give cause for concern

  • Gain an understanding of the Targeted Return Funds sector
  • Understand the various strategies employed by managers and the correlation with volatility
  • Be able to identify how these funds can be used in a portfolio
Absolute Return funds give cause for concern

The Targeted Absolute Return fund sector has attracted a certain amount of controversy in recent times. Lacklustre performance from some of the best-known portfolios has been accompanied by sharp drawdowns for others, highlighting the huge disparity in risk levels among managers in the space. The sector requirements set by the Investment Association (IA) means fund strategies can be vastly different, causing confusion for investors and analysts.

 However, with some portfolios still churning out modest, but seemingly reliable returns, fund buyers have backed the sector with a continuous stream of new money. Absolute return funds were among the most popular of 2016, and continued investor nervousness means the appetite for lower-risk products is unlikely to go away just yet.


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All weather?

The aim of targeted absolute return funds is to deliver positive investment returns regardless of the economic conditions. As a result, they will generally be suited to cautious investors seeking a belt and braces approach, but wanting more growth potential than cash deposits. As the FCA put it in the interim report of its asset management market study, the funds tend to suit “customers who wish to reduce the risk of negative returns”.

For this reason, targeted absolute return funds are likely to found in many investment portfolios as a useful diversification tool.

On the surface the description sounds fairly simple, but this is far from the truth. Attempting to guarantee positive performance in any market condition is some task, unless the risk is reduced to such an extent that the amount of growth becomes negligible. In some cases, strategies have gone badly awry and sustained serious losses.

Nor should all these funds be seen as straightforward replacements for bond allocations: even those that portray themselves as multi-asset in nature still tend to have relatively high correlations with equity market movements.

In spite of these concerns, absolute return has been the best-selling retail sector in seven out of the past eight quarters. This behaviour is replicated in the institutional space: the grouping has seen its annual sales increase for each of the past three years.

The start of 2017 has seen little change and the trend looks set to continue. In April – the latest month for which figures are available – only the specialist sector witnessed higher net retail sales, thanks to the launch of Neil Woodford’s new fund. In the last two months alone, just shy of £1bn has poured into targeted absolute return funds. 


Apples and pears

Any comparison of absolute return funds’ performance comes with one major caveat: the range of portfolios classified under this banner is extensive. Unlike other sectors, where the IA sets out clear eligibility guidelines, the rules for Targeted Absolute Return funds are broad to the point of ambiguity. 

The IA states the cohort is made up of “funds managed with the aim of delivering positive returns in any market conditions, but returns are not guaranteed. Funds in this sector may aim to achieve a return that is more demanding than a “greater-than-zero-after-fees objective.” 

“Funds in this sector must clearly state the time frame over which they aim to meet their stated objective to allow the IA and investors to make a distinction between funds on this basis. The time frame must not be longer than three years.”