Absolute return funds – the somewhat misnamed 100 or so funds that fall loosely into the Investment Association’s Targeted Absolute Return sector – have fallen on difficult times.
These funds, which cover a multitude of strategies, aim to deliver positive returns in most market conditions. But, as the IA warns, returns are not guaranteed.
Given the ongoing crisis largely caused by coronavirus, the latter point hardly needs to be emphasised, but, even before the grim reality of the pandemic hit the markets, these funds remained largely unloved.
As the chart shows, the sector has underperformed and recovered slower since the sell-off in March when compared with others, such as global and corporate bonds – although the sector did provide some downside protection when compared with equities.
If we take a closer look at the funds within the Targeted Absolute Return sector, we find that for the first half of 2020 only 40 out 115 funds generated a positive return; of these only 27 were positive since the market peak on February 20 and only two funds (BlackRock European Absolute Alpha and ManGLG Alpha Select Alternative) generated positive returns consistently throughout 2018, 2019 and during the two recent market sell-offs in Q4 2018 and year to date.
Over a three-year rolling period, 61 out of 98 funds provided a positive return, which is admittedly a lot brighter than it would have been just a few months ago.
These are not ‘no-risk’ funds. While absolute return funds want less volatility in their holdings than equity funds for example, they are still taking risk to try and add value in structurally challenged markets.
There are several big issues we see that have hindered performance in this sector.
The obvious issue recently has been volatility within the markets.
Wild swings in volatility – already there have been 25 days this year where markets have either risen or fallen by 3 per cent or more (for reference in 2008 as a whole there were only 17) – have undercut many fund manager strategies and left them flat-footed in terms of changing their allocations and understanding the longer-term impact Covid-19 will have on markets.
Over a longer time horizon, monetary easing has also played its part for absolute return funds.
The level of easing has added huge amounts to central banks’ balance sheets, dwarfing the figures from 2008 and hindering many managers’ relative value strategies by obscuring the performance of poorer companies.
Related to this, and perhaps most importantly, is the nature of the winners in recent years – namely equities with extremely high growth rates and valuations, a concentrated selection of US large caps, and government bonds.
Many of the funds within the sector are trying to offer something different and diversifying compared to these two asset classes (a traditional 60/40 portfolio), and as this trend has shown no signs of ending, naturally performance has struggled.