The group has rebalanced its risk-rated model portfolios and introduced absolute return funds for the first time.
Gleeson says that they are the only realistic way to dampen the volatility in portfolios given the serious issues in the bond market. "There’s no safe asset class anymore," he said. "There’s the capital value threat hanging over bonds, gilts are the traditional safe asset class but there’s downside risk there now, equities aren’t safe either, so there’s nowhere safe to go."
"Property proved not to be safe in 2008, so for short-term, low-risk portfolios, you have large amounts in cash, which is a significant drag on a portfolio."
"So we reduced our weighting to cash and increased it to absolute return."
Previously, the model portfolios had a much higher weighting to cash, which served a similar purpose.
However, finding truly diversified returns has become more urgent in recent months as the correlation between asset classes has been on the rise.
The most alarming example of this was the double fall in equities and bonds in June, which made a lot of investors look for ways to protect themselves against similar events, widely believed to be on the cards when the US Federal Reserve begins to taper its asset purchases.
Performance of equities and bonds in June 2013
Source: FE Analytics
"At the last rebalancing, eValue went negative on gilts and lowered the bond weightings and increased cash," he said.
"We didn’t follow entirely, but where they went to zero in gilts, we followed, but we weren’t quite so far into cash," Gleeson said.
"There wasn’t a need for them [absolute return funds] – we could diversify risk through traditional asset classes, which are much easier to model and understand. So at the time, we saw no additional benefits in them."
Another issue is that it is difficult to model the behaviour of alternative asset classes such as absolute return funds, which use complex strategies that are hard to form reliable generalisations about, to try to predict behaviour in different circumstances.
However, the FE Research team has always been wary of putting too much into cash – some of the low-risk models were suggesting much higher weightings than they were comfortable with.
There are other issues with using cash on a more mundane, practical level, Gleeson (pictured) explains.
"For advisers, telling someone to put their money in the bank is hard. You also can’t hold it as part of a stocks and shares ISA."
"You have to include the investors’ bank accounts within your assessment of their portfolio, which is complicated and a hard sell."However, a more pertinent consideration for all investors is that absolute return funds have a greater likelihood of producing real returns.
Cash practically guarantees a loss in real terms over any period of time. This can still be useful from a probabilistic modelling point of view, Gleeson explains, as a certain loss of 5 per cent can be better than a possible loss of 20 per cent when constructing a risk-targeted portfolio.
When raising cash to a large part of a portfolio, these losses become more significant however, and on a cost-benefit basis much less appealing.
Insight Absolute Insight was added to the three lowest-risk portfolios, while Standard Life Investments Global Absolute Return Strategies was a new entrant into two of the medium-risk portfolios.
Insight Absolute Insight is one of the least volatile funds in the IMA Targeted Absolute Return sector, which makes it an appropriate fund for the more risk-averse investor.
The £541m fund, which has five FE Crowns, has an annualised volatility of just 2.23 per cent over the past three years, compared with 14.96 per cent for the FTSE All Share.
In that time it has made modest returns of 11.42 per cent, according to data from FE Analytics, higher than the average absolute return fund.
Performance of funds vs sector and index over 3yrs
Source: FE Analytics
Standard Life Global Absolute Return, on the other hand, takes on more risk and has a track record of achieving higher returns.
The £17.8bn fund has an annualised volatility score of 4.65 per cent over the past three years, in which time it has returned 10.55 per cent.
The fund struggled over the summer and has yet to recover after the market dip in June.
However, the FE Research team is standing by it despite the recent high-profile departures from its team and the launch of a rival fund at Invesco last week.
Both funds have a reasonably low correlation to the FTSE All Share over the past three years, with the figure for the Insight fund – 0.54 – marginally higher than the figure for the Standard Life fund – 0.47.
The ongoing charges on Standard Life Global Absolute Return Strategies are 1.59 per cent and on Insight Absolute Insight 1.26 per cent.
Both appear on the FE Select 100, as do all the funds selected for the FE Select model portfolios.
