There’s an argument that those investing in absolute return funds should be among the least active investors. Granted the sector has an overly diverse range of funds – including long-only, long-short, UK centric, global and fixed interest funds – but those who can separate the wheat from the chaff should have no reason to move, given their desire to manage downside risk.
But this perception has not been the reality. The Investment Association Targeted Absolute Return (AR) sector has been among the most emotive for investors in the past decade or so, having seen steep inflows and outflows.
The sector still retains some popularity when markets face significant challenges but many investors have not forgiven its failure to protect assets in the past, most notably the challenges faced by a couple of significant funds which garnered large assets.
In a weird way the sector has delivered on the whole (it has produced positive returns in eight of the past 10 calendar years). Yet even after a strong 12 months, the dislike remains palpable with some £4.6bn of outflows.
Some fund managers we’ve spoken to believe it is because investors feel the sector offers no value to investors when you can get almost 5% in cash (the highest return for the sector in the past decade was 4.4% in 2019).
The detractors would say you can buy cheap government bond ETFs with decent yields for a few basis points. Many solid investment trusts also yield between 6 and 10% with reliable dividends.
The post quantitative easing (QE) world creates active opportunities
But the counterargument is that dispersion and stock selection are a bigger driver of markets today than they have been in the decade or so following the credit crunch. The pressure of QE is no more, with bond yields the leading factor in a growth-driven market. In short – sector and style dispersion creates opportunities.
Janus Henderson Absolute Return fund co-manager Luke Newman says performance of the fund has been impacted by the QE cycle. Today’s environment is similar to the first stage of the fund’s life (2004-2013), where the risk-free rate was >2% and equity dispersion was high. In this period the return over the risk-free rate was 8.2%.
The impact of QE saw the fund struggle between 2014 and 2020, with the risk-free rate at <2%. Newman says: “The spread of the risk-free rate on the fund fell to 1.1%. The challenge for us was how to dial down risk in the QE world – meaning more work around the bond market. We operated with less patience and booked profits sooner. All these things put a cap on deployed capital.”
He says today’s environment has been a pleasant return to normality – rather than markets being tied to monetary policy. Attractively-valued businesses, with positive catalysts, sound management and good balance sheets are the order of the day – investing in growth at any price is not a guarantee for success.
WS Ruffer Diversified Return co-manager Duncan MacInnes says he understands why investors would look to preserve their capital in cash, short-dated gilts and treasuries in this environment (a third of the portfolio is in the asset class). However, he says cash remains a terrible asset over the longer term.
He says: “When you go to cash you not only have to sell well (at the right time) you also have to time the move out of cash and back into the market, because you know over the longer term cash will give you a poor real return.
“I understand the de-risking, but timing the market is impossible. Clearly, there are moments where the performance comes thick and fast and you need to be invested at that point. You can have a cash buffer at this point, but this is not a permanent position and returns can come fast.”
I’ve said for a number of years that, despite there being a cloud over this sector, there remain a number of good funds that are delivering for investors over the long term.
Many have been waiting for an opportunity to stand out, and a world of higher interest rates may well be the perfect time to generate true and consistent alpha, and separate themselves from funds with mediocre performance.
Dispersion in performance used to be a bad thing for the sector (various fund types meant performance was all over the place), but now it is a good thing for managers.
Good examples to consider include the BlackRock European Absolute Alpha fund, which has returned 56.4% in the past 10 years. Those looking towards the bond market, might also consider the likes of the Artemis Short-Duration Strategic Bond fund, managed by Stephen Snowden.
Darius McDermott is managing director of FundCalibre and Chelsea Financial Services. The views expressed above should not be taken as investment advice.