There have been many voices casting doubts about the Investment Association Targeted Absolute Return sector over the years – and these voices have got louder in recent months, as a lack of performance has been matched by the challenge of comparing funds in what has become a hodge-podge sector. 
The sector is now home to 122 funds, the average size of which is just shy of £700m. Over three years to 20 May the average fund has returned 4.66 per cent – a solid if unspectacular figure – but that is arguably where the good news ends.
In the past, I’ve labelled the sector a zoo with many different “animals”: long-only; long/short; UK centric; global and fixed interest funds, are just some of the beasts sitting there. It’s a mix which makes no sense to me at all.
In fairness to the Investment Association they have launched a tool specifically for the Targeted Absolute Return sector, which allows users to look at performance over various timeframes – for example monitoring funds across benchmarks, risk ratings and sectors.
But vastly different funds are naturally going to lead to different performance returns. That is not always a bad thing in itself, but the gap should perhaps not be as big as it is, given all have been tasked with delivering absolute returns. ‘Caveat emptor’ has never been more appropriate: those returns are of course not guaranteed.
Let’s look at the disparity in performance in more detail. In 2018 the best performer returned 12.3 per cent, while the worst performer fell 13.5 per cent – a difference of more than 25 per cent. In 2017 the difference between best and worst was just over 60 per cent and in 2016 it was over 50 per cent.
The disparity has led to uncertainty and, when investors are uncertain, they tend to walk. As a result, the targeted absolute return sector has seen outflows of almost £4bn in the six months to end-March 2019 and was the worst selling sector during Q4 2018 – just the time when these funds should have been coming into their own.
But there are good funds in the sector – so for investors simply to put a black mark against all of them would be a mistake. I also think investors could be making a mistake by simply selecting one targeted absolute return fund and hoping it does the job in all conditions. A basket of these vehicles could potentially be the answer as a way of diversifying and, crucially, investing for a full market cycle. I cannot place a stronger emphasis on that point. It may not be the ideal solution for some, but it could offer the added security many hoped for when these funds first came into vogue.
Below are four target absolute return funds we like:
Brooks MacDonald Defensive Capital
This defensive, multi-asset fund aims for positive absolute returns over rolling three-year periods through a portfolio of defined return assets such as preference shares, loan notes, convertibles, structured notes and other defined return investments, including collective investment schemes and transferable securities.
The fund, which is managed by Jon Gumpel and Dr. Niall O’Connor, is designed to perform well in most market conditions, however, it is likely to underperform in very strong rising markets and outperform in flat, gently falling or gently rising markets.
BlackRock UK Absolute Alpha
Run by one of the best resourced and most experienced UK equity teams, the BlackRock UK Absolute Alpha fund is a very useful portfolio diversifier, with much lower volatility than the UK equity sector average.
Manager Nigel Ridge looks to achieve a positive absolute return for investors on a 12 month-basis, regardless of market conditions. It is a UK equity long/short fund and Nigel uses four main strategies: long positions, short positions, pairs trades and cash. The extensive primary research carried out by BlackRock’s equity teams ensures that the majority of added value in the team’s investment process comes from stock selection and the sharing of ideas is a key strength.
Jupiter Absolute Return
This is a unique absolute return fund in that although it is predominantly a long/short global equity offering, fund manager James Clunie has a large degree of freedom to manage the portfolio as he sees fit. James does not believe in second-guessing central bankers or policy makers. Instead, he prefers to insulate his portfolio against a range of different scenarios. The portfolio’s style will vary over time but generally it is likely to have a value bias.
This is the classic example of a fund which needs to be judged over a full market cycle, as it is the type of fund which will come into its own when markets are in a challenging state. It may lose small amounts over a couple of years and then make a big bounce back in challenging times – that is when James makes his alpha.
TwentyFour Absolute Return Credit
This is a straightforward absolute return fund with a solid track record of preserving capital and delivering strong risk-adjusted returns. Managed by Chris Bowie, it is effectively a bond fund as it does not short stocks.
The core of the portfolio is invested in investment grade bonds and floating rate securities, which are due to mature within a few years. Up to a third of the fund can also be invested in government bonds or high yield bonds, if suitable opportunities arise. This fund won’t shoot the lights out in terms of performance but will generate consistent returns making it a natural first port of a call for defensively minded investors.
Darius McDermott is managing director at FundCalibre. The views expressed above are his own and should not be taken as investment advice.