Multi-asset products that make extensive use of derivatives such as Standard Life Investments Global Absolute Return Strategies are “complicated beasts” that should not be used as a one-size-fits-all diversifier in a portfolio, according to Liontrust Asset Management’s John Husselbee.
The firm’s multi-asset head and manager of its model portfolio range said when looking at the alternatives space he considers two different types of fund: hedge funds and absolute return strategies.
“We have a definition that both [types] have to have a lower correlation to traditional asset classes. When it comes to hedge funds you want to be buying return enhancers,” he said.
“Typically, those types of vehicles tend to be global macro vehicles and I like the ones that have a limited number of trades but make big trades.”
These represent around 2-4 per cent of his portfolios, meaning that if these strategies fall 20 per cent in a month they do not impact the portfolio too much, while offering attractive returns over the longer term.
With absolute return strategies, Husselbee said these are in the portfolio to reduce risk, replacing the role traditionally held by bonds, which have been rising for much of the last decade alongside equities and look set for a period of underperformance.
Performance of indices over 10yrs
Source: FE Analytics
“I have only got [them] in the portfolio because my long-term view of bonds is one of higher growth, higher inflation and higher yield. I might get the coupon on bonds but – when I take that minus the capital value – I might get a negative return,” he said.
“I am trying to find essentially something that may not replace the whole of bonds but can take some of the strain off my bond holdings.”
However, one area Husselbee struggles to find value in is structured product and derivative multi-asset absolute return strategies that have become popular in recent years – the largest of which is SLI’s Global Absolute Return Strategies, or GARS.
“Structured products do offer diversification over the term of the structured product but month-in or quarter-out you are at the whim of too many factors for me,” he said.
“When someone says to me ‘how does that structured product work?’, I can tell them what it is supposed to do over a period of time. But how it works in shorter time periods I am not sure because we are at the whim of volatility and other market forces that on any given day can do anything it wants,” the Liontrust multi-asset head explained.
Funds that use structured products and derivatives are too complicated and offer little value to investors, said Husselbee.
“I am astonished at the amount of money that continues to flow into GARS and other such products. They are complicated and difficult to understand,” the manager said.
“Every trade they do to me is looking to gain hundredths of a basis point as they move and it seems the amount of transactions they make takes away a lot of the added gains and perhaps a lot of the alpha they are trying to achieve in the first place.
“I wonder if they are actually taking enough risk anyway as they are so controlling of volatility. It is a bit like the person that thinks about things so much that they never make a move.”
Additionally, Liontrust’s Husselbee said the complexity of the strategies makes it difficult for the average investor to understand, as they “seem to have lots going on underneath the bonnet”.
“I go around the country talking to advisers and listening to them and they think is that it [the asset management industry] is all too opaque and that they want more transparency. They [structured product funds] spoil it for the rest of us when we are trying to be more transparent,” he added.
However, Square Mile Research’s Victoria Hasler said these funds do have a role in a portfolio as long as they stick to the brief that they have set out.
Performance of fund on a rolling 3yr basis over 5yrs
Source: FE Analytics
“Even something like GARS if you look at it has not really performed outside the realms of what they said they were going to do because they have always said they have a three-year time horizon even though everybody measures them on 12 months,” said Square Mile’s head of research.
Although the £20bn fund has come under criticism over the last few years, it was not until the start of this year that it failed to make a positive return over a three-year-period, as the above chart shows.
“Actually if you look on a three-year basis it is not great but it is not shockingly bad – there are some funds out there that are worse,” she said. 
Yet even this recent fall should not be cause for concern for investors using the fund as a diversifier, as investors should be looking for zero or negative correlation in rising markets.
“The reason that most people buy these funds is not to make mega returns in bad years it is to diversify the portfolio. What you really want to see is a low or even a negative correlation to equities,” Hasler (pictured) said.
“If they are going to have that negative correlation to equities then it is not unrealistic in an up market for equities to expect them to be down slightly because that is what negative correlation is.”
And when markets fall, Square Mile Research’s Hasler added investors need to be realistic about the level of returns to expect, with a 3 per cent rise per year in a down market an acceptable return for these types of strategies.
Additionally, while some may seem these products as complicated, the funds have been very transparent in the trades they are making.
“The thing that people find difficult with them is the trades are all implemented through derivatives so these managers then start talking about treasury bund curve using the five-year/five-year or something like that and people think it is mega-complicated,” she said.
“I am not sure you need to understand each individual derivative to be able to understand the trades and what they are trying to do but actually, if you look into it, you can probably understand the derivatives because they are quite open about how they implement it all. It’s just most people aren’t really that interested.”
Overall, Hasler said it was down to individual managers and personal preference as to whether they invest in these types of products.
“You either let the managers use their expertise to make those more complicated trades and accept that they will do it for you or you say that it is too complicated for my client base and buy something else but accept that it is going to be more corelated to markets,” she said.