Many investors are considering alternative assets and sometimes quite exotic instruments, but data from FE Analytics suggests that equity funds could be the solution – at least those that use a market-neutral strategy.
Market-neutral funds use pair trades to try to hedge away the overall direction of the market.
This consists of backing one stock to go up – which in financial speak is termed "going long" – and backing another in the same sector to fall by "going short". Doing this removes all market risk: as long as the stock you are going long on outperforms the stock you are shorting, you make money, even if both stocks fall together.
The downside is that you stand to make less money from your correct stock-picks when the market rises, as you will be shorting as many stocks as you are going long on.
Data from FE Analytics shows that the few UK funds that use this strategy have managed to grind out uncorrelated returns over the past three years, with all displaying a low correlation to the index.
Correlation of funds with FTSE All Share over 3yrs
| Name | Correlation to FTSE All Share |
|---|---|
| Old Mutual Global Equity Absolute Return | -0.12 |
| Kames UK Equity Absolute Return | -0.07 |
| L&G UK Absolute | 0.17 |
| Insight Absolute UK Equity Market Neutral |
0.24 |
Source: FE Analytics
However, the funds have very different risk/return profiles, which may appeal to different types of investors.
While Old Mutual Global Equity Absolute Return has made 33.28 per cent over the past three years, compared with 42.35 per cent from the market, Kames UK Absolute Return has made just 8.57 per cent, with much lower volatility.
Performance of funds vs index over 3yrs
Source: FE Analytics
The largest IMA fund to use this strategy is the £801m Insight Absolute UK Equity Market Neutral portfolio.
The fund, managed by Andrew Caulker, Richard Howarth, Iain Brown and David Headland, is one of the underlying strategies held by the £504m Insight Absolute Insight fund.
Data from FE Analytics shows that the portfolio has made positive returns in each year since 2008, when it made 6.31 per cent and the FTSE All Share lost 29.93 per cent.
That was in fact the fund’s best year, and it has averaged annual returns of just 3.29 per cent since then.
The fund is likely to appeal to more cautious investors, with an annualised volatility figure of just 1.13 per cent over the past three years.
It all adds up to modest gains of 9.56 per cent over this time.
The fund requires a minimum initial investment of £3,000 and has ongoing charges of 1.17 per cent.
The £110.3m Kames UK Equity Absolute Return fund has a similar risk/return profile to the Insight portfolio.
This fund is managed by David Pringle and David Griffiths, and, like the Insight fund, invests in UK stocks.
Our data shows it has a volatility of 2.1 per cent over the same period, but its ongoing charges of 1.57 per cent are slightly higher. It requires a minimum initial investment of £500.
The five crown-rated Old Mutual Global Equity Absolute Return fund offers the chance for higher returns at the cost of more volatility.
The $138m fund, managed by Ian Heslop, Amadeo Alentorn and Mike Servent, has a wide remit, able to buy stocks in global equity markets.
It has returned 33.28 per cent over three years, at more than twice the volatility of the Kames fund, although this still only comes in at 5.1 per cent, three times less than the 15.11 per cent of the FTSE All Share.
Most impressive is the fund’s performance when the market falls.
The FTSE All Share lost 16.98 per cent between 7 July 2011 and 10 August 2011, but the Old Mutual fund made 5.33 per cent.
In 2012 the markets fell again, the All Share losing 10.06 per cent between 13 March and 21 May and the Old Mutual fund making 0.81 per cent.
Over this summer the fund again successfully protected investors’ capital, making 1.06 per cent between 21 May and 24 June as the FTSE All Share lost 10.76 per cent. The UK bond market lost 4.13 per cent over the same period.
Performance of fund vs index
Source: FE Analytics
The fund requires a minimum initial investment of £1,000 and has ongoing charges of 1.99 per cent.
L&G UK Absolute has a similar risk/return profile, although it invests mainly in UK equities, with some European stocks.
The fund is slightly more volatile – at 7.26 per cent – and has made less money over the past three years – 20.18 per cent.
As the riskiest fund on the list, it has the largest maximum drawdown – 5.35 per cent – and the biggest maximum gain – 8.23 per cent.
It requires a minimum initial investment of £500 and has ongoing charges of 1.8 per cent.
The £29.7m fund was taken over by new manager, Guy Rushton, at the beginning of this month.
In recent articles, FE Trustnet has looked at multi-asset absolute return funds and long/short absolute return funds. This weekend, FE Trustnet will be looking at finding uncorrelated returns from a retail investor’s point of view.
