Time for AR funds to show their true mettle

This could well lead to some awkward conversations between intermediaries and clients nervous about their investments. But it also prompts another question: what products should advisers turn to as a way of protecting assets, or at least lessening the pain, when markets take a tumble?

One area has proved especially popular in the wake of the financial crisis: multi-asset absolute return. This category of funds, which aims to produce a positive return over a rolling period, often of between one and three years, has gathered significant assets in the past decade. The best-known names, from Standard Life Aberdeen’s Global Absolute Return Strategies fund to peers at Aviva Investors and Invesco, have amassed substantial amounts of money. Many others have entered the space in recent years: more than 30 multi-asset funds currently sit in the Investment Association’s Targeted Absolute Return sector.

The fact these funds focus on capital preservation rather than growth means they should have protected portfolios during the widespread market falls witnessed in the final months of 2018. Equally, many seek to offer exposure to assets uncorrelated to equities. With investors now expecting more volatility of the sort seen last year, this should be an ideal time for absolute return funds to prove their worth. But many have run into trouble on several fronts. The first concerns performance: a look at returns from the higher-profile names shows they have not behaved as they were expected to in moments of market turbulence.

Aviva Investors’ Multi Strategy Target Return fund lost more than 5 per cent over this period, and while SLI Gars and Invesco Global Targeted Returns did better, both had slumped earlier on in the year.

While this is only a snapshot, a longer-term view does little to flatter performance. Over one year all three names lost money and, over three years to January 16 2018, only Invesco’s fund managed a positive return, of 1.1 per cent. The poster boys of the sector, at least, have struggled to live up to expectations (see Table 1).

Table 1: Performance of top and bottom five absolute return funds

Note: Figures as of January 16 2019. Source and Copyright: Money Management

An Aviva Investors spokesperson says the firm has made changes to its portfolio management team, and strengthened in a number of areas to help improve processes and performance. 

Invesco head of multi-asset David Millar acknowledges 2018 was “a tough year for us and a lot of funds in the sector”, and says the team will continue to concentrate on good long-term returns.

A spokesperson for Gars says the fund’s realised volatility has remained consistent with its expectations, as has long-term performance. They add that the portfolio’s sensitivity to economic downside scenarios has been “much reduced” as a result of changes made in 2018 – and Gars did hold up relatively well in the dramatic fourth quarter of last year. A disconnect has perhaps emerged between those funds that are positioned more cautiously on equities, such as Gars, and those like Aviva that anticipate a restoration of market confidence this year.

Natixis H2O MultiReturns, which aims to significantly outperform the one-month London interbank offered rate over three years, was the only multi-asset absolute return product that made a positive return in 2018. Admittedly, this was no easy task amid widespread market falls.

Many of the offerings have also fared better over longer time periods: as of mid-January, around 20 of the funds with a three-year track record had made gains over this period. Several of these, including 7IM Real Return, Barings Multi Asset and L&G Multi-Asset Target Return, notched up double-digit growth.

Popularity contest

Has this been enough to persuade investors that such funds are worth backing? A look at fund flow data suggests not. In November 2018, the IA’s Targeted Absolute Return sector fared worst of all the sectors, with UK retail investors taking out £756m on a net basis. 

The picture looks bleak over the year to the end of November too, with the sector being hit by net outflows of more than £1bn. As we reported in last month’s issue of Money Management, much of this will be down to many calling time on the group’s biggest constituent: investors took nearly £6bn out of SLI Gars last year on a net basis. As Chart 1 shows, another multi-asset absolute return name, Newton Real Return, registered net outflows of more than £2bn, according to Morningstar.

Others have continued to gather assets at pace, as both professional and direct-to-consumer investors look for funds less correlated with rocky equity markets. But intermediaries still have their work cut out for them when it comes to picking the most appropriate funds for clients.

The IA sector that houses many of these products remains highly disparate: it contains multi-asset names looking to generate consistent positive returns, but also fixed income offerings with a similar remit and several long/short equity products. As a result, the approaches on offer vary wildly: some funds in the sector look to grind out steady, if modest, returns, while others offer something more high octane.

One sector member, City Financial Absolute Equity, provides a good example of the more adventurous approach. This long/short fund is up nearly 11 per cent over five years, but has made losses of around 20 per cent over both a one and three-year time horizon. This comes despite it having gained nearly 10 per cent during the volatile month of October 2018.

So the peer group is a good reminder that advisers – or those to whom they outsource investment decisions – must carry out substantial due diligence on the products they back.

Complicated or clever?

There are other issues when it comes to filtering out the absolute return funds best suited to portfolios. While all multi-asset funds tend to buy a variety of different assets, from stocks and bonds to more esoteric fare, Gars and its peers also tend to “pair” trades, betting the fate of one asset against another.

An end-of-November update from the fund lists several conventional investments, from US equity exposure to positions in global real estate investment trusts. But other strategies are less straightforward. These include a play on US real yields versus Japanese interest rates, UK versus German duration, and Asian versus S&P variance.

While such strategies could pay off handsomely, and potentially offer exposure uncorrelated from traditional assets, their use raises questions for the high-profile absolute return names. That’s because they remain difficult for clients, and even some professional investors, to understand. Using a more convoluted strategy muddies the water for those trying to work out what has gone right or wrong with a portfolio, and how it could perform in different scenarios.

Providers, in fairness, have made concerted efforts to explain their strategies and how their investments have played out. But issues like these will continue to dog fund firms at a time when the absolute return approach is arguably needed more than ever.

Intermediaries and clients will undoubtedly show interest in the sector at this late stage in a bull market. But with plenty of disparate products on offer, taking the time to make the most suitable choice will prove worthwhile.