Only seven of the 55 members of the IMA Targeted Absolute Return sector – including the $1bn Schroder ISF Asian Bond Absolute Return portfolio – failed to at least break even last year. The average absolute return fund managed an inflation-busting 6.26 per cent, with a volatility significantly below that of equities and bonds.
Performance of sectors and indices in 2013
Source: FE Analytics
Four of the seven funds that lost money in 2013 have a specific focus on a region – either Europe or emerging markets. Both areas had their share of difficulties last year, particularly emerging market debt, which experienced a vicious sell-off following the announcement in May of the Fed's plan to begin tapering its QE programme.
Other notable loss-makers include the £333m Threadneedle Absolute Return Bond fund, though it only shed 0.88 per cent. Liontrust European Absolute Return was the worst performer overall, with losses exceeding 7 per cent.
Source: FE Analytics
Given that interest rates are still at historic lows of 0.5 per cent, it is hardly surprising that all of the funds that made a positive return last year also managed to outstrip cash.
Four funds – Old Mutual Voyager Alternative Investments, Schroder Absolute Return Bond, RWC Core Plus and Hugh Hendry’s CF Eclectica Absolute Macro portfolio – did fall short of inflation, measured by the consumer price index (CPI).
Hendry has been notoriously bearish of late, which cost the fund last year as a result of the strong performance from a whole host of risk assets. The manager has become more constructive in recent months, however, telling investors that he is willing to jump on the QE bandwagon.
Speaking at a conference at the end of last year, he said: “I have been prepared to underperform for the fun of being proved right when markets crash. But that could be in three-and-a-half-years' time.”
The other end of the scale is dominated by funds that have been prepared to take on more risk: namely the CF Odey Absolute Return and City Financial UK Equity funds, which returned 45.02 and 31.62 per cent over the 12-month period, respectively.
Both are long/short equity funds, with hefty long books at present. In fact, all of the five top-performing absolute return funds of 2013 have the ability to make money from falling share prices, including FE Alpha Manager Paul Marriage’s Cazenove Absolute UK Dynamic portfolio.
Performance of best absolute return funds vs sector in 2013
Source: FE Analytics
While overall return is of course important to all investors, holders of absolute return funds will also be interested to see how their portfolios coped with volatility over the period.
Absolute return funds are designed to minimise risk for investors and to be held over shorter-time frames than equity funds, for example.
The biggest challenge to the sector in 2013 was the announcement of possible QE tapering by the US Federal Reserve in the early summer.
As the graph on page one illustrates, the average absolute return fund protected against the downside far more effectively than the average bond and equity funds over the period, though still experienced a slight drawdown.
Some funds, including Standard Life GARS, lost more than 5 per cent of their value from peak to trough over the summer, as reported by FE Trustnet at the time.
The £18.4bn vehicle, which is by far the largest and most popular in the sector, has still failed to make back the losses it sustained over the two-month period, though still finished 2013 more than 6 per cent in the black.
Performance of fund and sector since Jan 2013
Source: FE Analytics
Many high-profile absolute return funds, including the five top performers mentioned above, have been significantly more volatile than their sector average, with the Odey portfolio boasting an annualised volatility similar to that of the FTSE All Share, for example.
That said, the Odey fund did manage to make money in May and June when the market fell.
A good way to look at whether an absolute return fund has been successful from a risk-adjusted return point of view is to look at its Sharpe ratio, which measures its return relative to a notional risk-free investment – in this case, cash. The difference in returns is then divided by the fund's volatility.
In 2013, the stellar performance of the long/short funds mentioned earlier ensured that they also came top in terms of Sharpe ratio. CF Odey Absolute Return topped the tables with a score of 4.58, with Henderson European Absolute Return and Cazenove Absolute UK Dynamic also scoring in excess of 3.0.
Looking at funds with an annualised volatility of below 3 per cent over the 12-month period – a score well below that of the IMA Sterling Strategic Bond sector average – a handful of portfolios stand out.
Top of the pile is BNY Mellon Absolute Return Equity, which had a Sharpe ratio of 2.43 in 2013. The £865m fund uses a market-neutral approach, meaning that it attempts to strip out the effect of equity markets on performance. It does this by placing long and short bets in stocks from the same sector.
Our data shows that it returned 6.54 per cent last year, with an annualised volatility of just 2.19 per cent. The fund had a max drawdown – which measures how much an investor would have lost if they bought and sold at the worst possible moments – of just 1.34 per cent.
Performance of absolute return funds in 2013
Source: FE Analytics
Insight Absolute Insight UK Equity Market Neutral operated with an even lower volatility and max drawdown over the period, though returns of just 3.52 per cent mean that its sharpe ratio is less than that of the BNY fund.
Insight Absolute Insight, which has a major stake in the market-neutral fund as well as a number of other Insight portfolios, had another strong year from a risk-adjusted return point of view. It has managed to generate a positive return in five of the last five consecutive calendar years, and only lost 0.18 per cent in 2008.
Premier Defensive Growth, which invests in the preference shares of investment trusts, is also well worth a mention. It returned 4.66 per cent last year, with an annualised volatility of 1.15 per cent.
Click here to learn more about absolute return investment strategies, with the FE Trustnet guide to absolute return.
