Investors should be allocating to absolute return funds in the current market environment or, failing that, should be sitting it out in cash until the outlook appears more positive, according to City Financial investment director Peter Toogood.
Toogood has been highlighting absolute return funds as his preferred area of investment for some time now owing to a lacklustre economic backdrop and says that conditions have not improved more recently – in fact, they are looking even more worrying.
“We have remained doggedly cautious with regard to risk assets since last June, arguing that markets were increasingly dysfunctional. After the sell-off at the start of the year, we had suggested a strong bounce was due, but we believe that you have seen the best of the recovery in asset prices and we would again be very wary,” he said.
The investment director argues that the global economic backdrop appears weaker than many believe and warns that this could lead to another sell-off when the market catches up to the fact that the economy is not performing as expected.
“The “recovery’ has been in fits and starts and predicated on the ludicrous assumption that 6 to 7 per cent nominal world GDP growth, which was achieved in the noughties, is ‘normal’. It also ignores the fact that the bulk of the incremental economic growth in that decade was in fact sourced from the emerging markets, which themselves are now struggling due to weaker commodity prices, or credit busts, or both,” he said.
“Central bankers continue to push on a string, but inflated asset prices are as much a hindrance as a positive now, especially when you base monetary policy around their performance. We would argue that asset prices are now very vulnerable especially given the deteriorating outlook for profitability globally.”
Performance of indices since 2009
Source: FE Analytics
Toogood also argues that this assessment of the economic backdrop is not reflected in asset prices as he believes that equity prices have become “increasingly out of touch with economic reality” since early 2015.
He says that the US stock market – which has rallied hardest in the post-financial crisis world – appears expensive on almost every valuation measure. “On some measures, ludicrously so,” he added. “The brutal and blunt truth is that every valuation measure is flashing red in the US.”
When it comes to Europe, an area often highlighted as being a pocket of value in global markets, Toogood says it only looks cheap because of the presence of very lowly-valued commodity stocks, especially in the UK, and utilities and financials stocks in continental Europe. The median stock and almost all growth stocks in Europe are as expensive as their US peers, he says.
“Our advice has been unwavering throughout this period, namely, if you must invest in risk assets, favour absolute return funds. We appreciate that absolute return funds are not everyone’s cup of tea and if that is the case, we would suggest you stay on the sidelines in cash,” the investment director said.
“The real economy remains vulnerable but the authorities have traditionally responded only when asset markets riot. We still believe that a combination of debt monetisation/forgiveness and a rejection of austerity in the ‘balance the books’ sense of the word is the end game for the global economy and therefore for asset prices.”
“The early years of the 1980s were the peak of the inflationary bust – we think the next few months into 2017 will see the peak of the deflationary bust. Unfortunately asset prices do not reflect how severe that bust might actually be.”
“Be cautious for now but be alive to the fact that a new bull market will eventually emerge and it will be based on the fundamentals, not the whim of central bankers.”
City Financial rates a number of funds highly in its The Adviser Centre resource, with five – Newton Real Return, Invesco Perpetual Global Targeted Returns, Henderson UK Absolute Return, Henderson European Absolute Return and Absolute Insight Emerging Market Debt – receiving a ‘recommended’ rating.
Performance of fund vs indices since launch
Source: FE Analytics
Invesco Perpetual Global Targeted Returns has built up a strong following since its launch in September 2013, with its assets growing to £5.4bn. As the graph above shows it has outpaced the FTSE All Share by more than 10 percentage points since inception, achieving these returns with an annualised volatility of less than half of the index’s at 4.09 per cent.
The fund’s investment process is based around its managers’ macroeconomic and scenario analysis. The portfolio is then built around 20 to 30 investment ‘ideas’ from a wide range of asset classes, geographies, sectors and currencies.
Invesco Perpetual Global Targeted Returns is headed by David Millar, Dave Jubb and Richard Batty, who were instrumental in building the track record of the popular Standard Life Investments Global Absolute Return Strategies fund. This £26.2bn fund has an ‘established’ rating from The Adviser Centre.
Newton Real Return, which is managed by Iain Stewart, is another stalwart in the absolute return space. The multi-asset portfolio aims for positive returns in all conditions with volatility somewhere between bonds and equities.
Like all of Newton’s funds, it follows a global thematic approach to investing that looks at how structural changes such as demographic shifts or growing debt levels could affect the global economy and builds a portfolio around that view.
Newton Real Return has made a 69.93 per cent total return over the past 10 years, outpacing the 53.64 per cent gain in the FTSE All Share but below the 80.29 per cent made by the Barclays Sterling Gilts index. Its annualised volatility has been 7.53 per cent, against the All Share’s 14.12 per cent and gilts’ 6.27 per cent.
Performance of fund vs indices over 10yrs
Source: FE Analytics
Henderson UK Absolute Return, which is managed by the FE Alpha Manager duo of Ben Wallace and Luke Newman, is a long/short fund investing in UK equities. The fund holds five FE Crowns and is a member of the FE Invest Approved list.
It aims to deliver a positive return in each year. While this is not guaranteed, the fund has achieved this in each of the six full calendar years since 2009. Since launch it has made a 58.60 per cent total return.
