Many predicted 2014’s volatility before the year started but, with equities still seemingly the asset class of choice, protecting the downside can be a tricky call when there is still good money to be made.
While 2012, and to some extent 2013, was rather a one-way bet on risk assets, investors are again looking to absolute return funds to deliver on their promises across both equity and fixed-interest strategies.
Fusion and evolution
The sector has evolved since the last downturn, at least in terms of new launches. Whereas absolute return once meant long/short equities, today’s wealth manager has a plethora of options to choose from, including funds that invest across different asset classes and take a different stance on the absolute return concept.
For example, given the massive success of its £20bn Global Absolute Return Strategies (GARS) product, Standard Life Investments has just launched Global Focused Strategies.
Run by the same multi-asset team, it is billed as an ‘advanced fusion’ with macro and micro capabilities. The fund offers an ambitious cash-plus 7.5% return, with expected volatility of 6-12%, compared with a cash-plus 5% target from its bigger brother.
Elsewhere, Lyxor fields its Quantitative Absolute Return Multi Assets offering with annual volatility of lower than 3%, and the fund is marketed very much as a diversifier that can be held alongside GARS.
Meanwhile, Natixis affiliate H20 has launched MultiReturns, a macro-driven vehicle that aims to outperform one-month Libor by 4% per annum. The fund is promoted as the only income-paying fund in the IMA Targeted Absolute Return sector with a 3% coupon.
“In the UK, we wanted to add the coupon as we thought investors would be happy to use an income-generating vehicle. The second difference we have is our approach – we are a lot less directional than other investment solutions,” says H20 chief investment officer Vincent Chailley.
“Absolute return funds are usually what you might call ‘smart beta’ solutions, which are built through dynamic asset allocation calls. The big performance engine for us is more alpha than beta, with relative value positions more than directional positions. We are a lot less exposed to equities, bonds or rates than the average competitor.”
Break with tradition
This new breed of funds shares a degree of complexity with multiple strategies that are more traditionally associated with the institutional rather than retail marketplace.
Ignis Global Absolute Return Government Bond Fund is another modern success. Launched in March 2011, it is already up to €3.33bn (£4.64bn) in size, which director of fixed income Helen Farrow attributes to its unique diversification benefits.
In common with Chailley, Farrow believes that many of the funds labelled as absolute return carry too much beta.
She says: “From looking at an index of composite absolute return managers you can see that there are a lot of funds that historically did well in 2006-07 and then lost a lot of money in 2008.
“Even over the past year, you can see clearly what happened when we had the May/June emerging market sell-off and the realisation that tapering was coming. So many funds just lost money at that point, an indication of having too much beta.”
Rather than fearing volatility, Farrow believes it should be an absolute return fund manager’s best friend. She says: “Volatility is great because that’s what you actually want – we can trade volatility itself.
“I agree markets are going to become a lot more volatile and the end of quantitative easing could mean yields will rise and there will be a lot of volatility around that trend.
“If you are doing it properly, absolute return funds should be able to make money regardless of what is going on in the underlying market. A fund should generate a positive return over any rolling 12-month period if it is doing its job well.”
Different strokes
As the saying goes, there’s more than one way to skin a cat, and those investors uncomfortable with putting their money in the hands of the multi-strategy derivatives-based managers may wish to look elsewhere for absolute returns. Indeed, for some managers absolute returns can be achieved with a very basic long-only approach, providing the primary focus is on capital protection.
Is this a wise strategy in a world where equity and bond markets are likely to exhibit more instability? Ruffer is one of the most highly regarded proponents of a long-only absolute return approach with its £2.9bn Total Return Fund.
Co-managers Steve Russell and David Ballance currently hold a mix of index-linked bonds, gold and developed market equities, believing the ongoing debt crisis that was exposed so spectacularly five years ago will eventually end in inflation.
They have a good track record behind them, too, having delivered double-digit returns in 2008 when most others floundered.
Russell is clear that “when it is easy to make money, we’ll struggle”.
He adds: “The question is are some funds multi-asset for the point of being multi-asset or do they hold the underlying assets for specific reasons? Everything we own is held for a specific reason and a specific scenario. We might be wrong about the scenarios but we hope we are not wrong about how we think the assets will perform.
“In this asset class investors should be wary when times are difficult, as correlations tend to rise horribly and things that might have looked safe often aren’t.”
Kennox also adopts a long-only approach with its £260m Strategic Value, though this fund hopes to achieve absolute returns solely through a narrow selection of about 30 global equities. Current sector biases include oil, healthcare and telecoms.
The focus is on capital preservation, although the fund will suffer when markets crash. Manager Geoff Legg says drawdowns have been roughly one-third of that of the market since the fund launched in the UK in 2009.
“It’s an interesting approach to equity investing – focus on the downside and then just by being exposed to the equity market, your long-term returns ought to be good,” he says.
“The mindset is absolute return but the approach compared to most absolute return managers who are multi-asset or heavy users of derivatives, is completely different. We market to those attracted by the absolute return profile but who want equity exposure.
“In 2012-13, everyone was asking if you could really afford to be out of equities. Regardless of what you believe about the valuations of the market, it was painful not being exposed to equities when they were booming.”
Stand and deliver
So can you rely on absolute return funds to deliver when the going gets tough? The truth is there are no guarantees in this business and if you are not relying on a manager to pick the right value ideas, then you will be relying on them to get the macro right. And in the current environment, with uncertainty on interest rates, inflation and quantitative easing, that is never going to be easy.
Stewart Smith, investment research manager at Rayner Spencer Mills Research, sums it up when he says: “Absolute return now means different things to different people.”
He adds: “It is about distinguishing between things like market neutral and pure long/short funds, and the different risks each strategy brings, and then picking the right one for the right situation.”
“It is important that while an investor may not necessarily understand the full mechanics of how a fund is run, they certainly have to get a good overview of what types of strategies are being used and what risks they might be exposed to.”
