A combination of soaring inflation, rising interest rates, ongoing issues with global supply chains and the war in Ukraine has had a significant impact on investor sentiment, writes Square Mile investment research analyst Tom Archer (pictured).
This is reflected in sales of retail funds in the UK – the IA reported negative fund flows every month in the first quarter of this year.
This is perhaps unsurprising given equity market performance over the quarter with UK equities up slightly by 0.5%, while UK smaller companies fell 11.4% and Europe was down 7.4%. Fixed income provided little protection with UK government bonds and sterling corporate bonds down 7.2% and 6.6%, respectively.
With little prospect of a return to market stability any time soon, where can investors seeking some degree of downside protection turn?
Funds within the IA Target Absolute Return sector, or within other comparable sectors that employ some degree of hedging, should be a consideration. Unfortunately, the reality is that many such strategies have failed investors over the years and the sector as a whole has a somewhat tarnished reputation.
However, among the chaff there is wheat and a handful of funds have succeeded in both delivering returns and, importantly, protecting investor capital during period of market duress.
NB Uncorrelated Strategies
Sitting in the IA Flexible Investment sector, this is a unique fund with characteristics that we believe makes it a very useful building block in diversified portfolios. In particular, the fund’s returns since inception have been negatively correlated to those of equity markets.
The fund protected investors’ capital to a high degree in the stock market sell-off in Q4 2018, delivered a gain as stock markets plunged in Q1 2020 and was again profitable in Q1 2022. It comprises a range of complementary and sophisticated investment strategies which most investors would probably be reluctant to allocate to on a standalone basis.
However, the fund’s management team is deeply resourced and very experienced and the way that investments are structured allows the team to monitor and control risks and exposures within the fund in real time.
Trium ESG Emissions Impact
There are not many highly-hedged equity long/short funds available to retail investors and this fund is a rare example. Managed with very low net market exposure, stock selection of both long and short investments is the primary driver of returns.
Although the track record is still relatively short, Joe Mares, the fund’s manager, is a highly experienced investor in the sectors in which the fund invests and, most importantly, is also an experienced and accomplished short seller.
In addition, the fund’s track record already spans periods of both stock market exuberance and turmoil. We believe that the rich opportunity set and the skill and experience of Mares gives the fund a very good chance of delivering attractive returns in all market conditions.
In particular, the fund’s low net market exposure should also lead to a high degree of capital preservation during significant stock market corrections. This has already been evident in both Q1 2020 and Q1 2022.
Fulcrum Thematic Equity Market Neutral
This is a long/short equity fund which is managed with low net market exposure and so stock selection is the main driver of returns. The fund sits in the FO Hedge/Stru Prod – Equity sector and takes long and short exposure in medium- and long-term (2-5 years) investment themes, driven by emerging technologies, megatrends and strategic change.
In taking exposure to a theme, the fund’s manager seeks to maximise the number of component investments in order to minimise stock-specific risk. Although the fund’s gross exposure (long exposure plus short exposure, including hedges) often exceeds 200%, the fund’s experienced management team has demonstrated very strong risk management discipline and will rapidly reduce both overall and theme-specific exposure when it is deemed appropriate.
Due to the fund’s very low net market exposure and the investment team’s risk management culture we believe the fund has a high probability of protecting investors’ capital in major stock market sell-offs. The strategy was profitable in both Q1 2020 and Q1 2022.
All-in-all, this fund meets the criteria we seek in an absolute return fund and we believe it is a strong candidate for inclusion in diversified portfolios.
Janus Henderson Absolute Return
This equity long/short strategy is intended to be a ‘sleep-well-at-night’ fund, providing steady returns and avoiding significant drawdowns. The managers have a good long-term record of stock selection (and therefore generating alpha) and have also protected investors’ capital to a high degree in periods of market stress.
We believe the fund should continue to exhibit similar return characteristics in the future. It does have a net-long bias, typically between 15% and 30% net long, so we would not expect it to be completely immune from broad trends in stock markets.
However, this has not undermined its ability to preserve capital to a high degree in the past when stock markets have tumbled.
By investing in this fund, investors are entrusting their savings to a highly experienced and proven team who are unlikely to subject them to any nasty shocks or surprises.
This article was written for Portfolio Adviser by Tom Archer, investment research analyst at Square Mile Investment Consulting and Research
