Absolute ReturnSep 26 2018

Investment advisory sector still divided on absolute return funds

twitter-iconfacebook-iconlinkedin-iconmail-iconprint-icon
Search supported by
Investment advisory sector still divided on absolute return funds

Indeed, absolute return funds have polarised the investment advisory sector for many years.

Cynical attitudes towards them have not been helped by recent headlines about Standard Life Aberdeen’s (SLA) Global Absolute Return Strategies (Gars) Fund, which has shed assets as performance has fallen.

According to Morningstar data, the total net assets of Standard Life Investments Global Absolute Return Strategies has fallen by 28.2 per cent to £16.2bn over the past year.

So is this a sign that absolute return funds are going out of fashion?

Absolute return funds tend to be at the more expensive end of the investment fund sector and some of them have performance fees attached to them.Martin Bamford

The premise behind them is that they have a wide range of tools in their toolbox to use to their advantage depending on the market environment.

Emma Saunders, a research analyst at Rathbones, said: “Absolute return funds have the potential to make returns over different stages of the market cycle by participating on the upside when markets are strong, but also have the flexibility to rotate the portfolio into short positions or derivatives for protection during periods of equity or credit market stress.

Key points

  • Absolute return funds have polarised the adviser sector.
  • They grew in popularity following the financial crisis.
  • They tend to be at the expensive end of the investment sector.

“They do this by taking long and short positions across different asset classes and derivatives, and may use these tools to capitalise on relative value opportunities. 

“Typically, these funds have risk parameters embedded in the process, so even during periods of strong market performance, participation on the upside can be to varying degrees. However, the capital preservation mindset is typically at the forefront of any objective and therefore the resulting return profile should be uncorrelated to equity markets with a low beta over the long term.”

History

They have been in existence for some time but grew in popularity in the wake of the 2008 global financial crisis.

Historically, investors have depended on a diversified portfolio of traditional asset classes to provide protection during periods of equity market drawdown.

However, the financial crisis highlighted the risks of this approach, whereby the market saw credit securities suffer alongside equities, Ms Saunders said.

She added: “We saw an increase in demand for strategies with a low correlation to equity markets that can provide the benefits of diversification that investors seek in periods of market stress.”

Charles Hovenden, portfolio manager at Square Mile Investment Consulting and Research, explained: “Lots of people jumped on the bandwagon and it has been a mixed experience thus far. One of the problems has been that there have been very few tests in stock markets for investors in recent years.”

What advisers like

Advisers who favour absolute return funds say this is because they can be a useful tool in building a diversified portfolio, according to Adrian Lowcock, head of personal investing at Willis Owen.

He said: “Because we have been in such a long bull market for equities it is very easy to forget the importance of being diversified out of equities. 

“The advisers who like it are the ones looking at the current situation; looking at what happens to an investor’s portfolio if there is a downturn, or we go into a bear market.

“They are looking at the risk of adjusted returns they will get for their clients in a diversified portfolio. It has been a hard environment for absolute returns. Their function isn’t to perform excessively well in a bull market. Their job is to protect your capital over the whole cycle. It just so happens we have been in a longer cycle.” 

What advisers do not like

Martin Bamford, managing director of Informed Choice, is not a fan of absolute return strategies. 

He argues that only a small number of these funds deliver on what they are supposed to – after charges and price inflation – and those funds that do are not doing it on a consistent basis.

Mr Bamford added: “Absolute return funds tend to be at the more expensive end of the investment fund sector and some of them have performance fees attached to them.”

Advisers who stay away from absolute return funds say it is because some of the funds in the sector have experienced disappointing return profiles in recent times.

Mr Hovenden said: “So for three or four years you have made no money, meanwhile stock markets have been on a tear.

“If you are a client of an adviser, you might be saying, ‘Why am I in this thing that is making me no money?’.”

Despite the fall in performance among some of the largest funds, interest in absolute return funds has continued to grow, which has resulted in several product launches across different asset classes and across model-based and discretionary approaches.

Advisory approach

While some funds in the universe have achieved their objective to varying degrees, others have been criticised for failing to protect investor capital over the long term, Ms Saunders said.

She added: “Close attention should be paid to what the individual strategies are looking to achieve and how they are going to achieve it.

“Many absolute return funds have come under criticism for being opaque and expensive, with disappointing performance. This increases the importance of strong fund selection which can identify not only the best of breed funds, but also looks to avoid those names with questionable approaches and outputs.”

Mr Hovenden said, despite the common belief that these funds are complex, there are still tactics advisers can use to help them understand the funds better.

He added: “If you break down Gars and the other similar funds, they typically have 30 trades in them and the trades may be long or short, or relative value, ie two-legged trades. Each of these trades, individually, is easy to understand.

“The view on the [Square Mile] team here, is the way to play this sector is through a basket approach. You would not want to own just one fund. Knowing that Gars might be vulnerable in a stock market downturn, I might look to pair that with Jupiter Absolute Return, which has the opposite characteristics.”

Regulatory interest

The complexities associated with absolute return funds have prompted the Financial Conduct Authority to pay closer attention to this sector.

In 2016, in its asset management market study, the watchdog said the wide range of charges and targets could be confusing to retail investors, and is unlikely to help investors compare performance even within the absolute return sub-sector.

It has since ordered firms to set out clear, consumer-friendly objectives, and provide consumers with information on how they should evaluate the performance of the fund –for instance, using a target against a benchmark or absolute return.

Mr Lowcock sees value for investors putting their money in absolute return funds, but he is a staunch advocate for more transparency in the manner they are explained to investors.

The aim of absolute return funds is to reduce risk adjusted returns and provide the tools available to help mitigate market drawdowns. As some have come under scrutiny for not achieving their objectives, Ms Saunders stressed that robust due diligence is critical.

Ima Jackson-Obot is a features writer for Financial Adviser and FTAdviser.com