The strong re-rating of the first part of 2013 has given way to a period in which the market has been broadly flat, and the consensus is for limited gains from equities this year with a correction quite possible on the way.
In fact, markets are only 0.64 per cent up from their peak in May last year.
Performance of FTSE All Share since Jan 2013
Source: FE Analytics
Julian Lewis, manager of the Cavendish Balanced Income fund, said: “I don’t think markets being particularly strong in the short term.”
“You had a good rise last year followed by a period of digestion in which the market is going largely sideways. I think this will continue for some time.”
Charles Younes, research analyst at FE, says that in the current market environment it makes sense to look at long/short funds.
These have the ability to go short a stock as well as long, meaning they stand to make money if the share price falls.
This gives them extra freedom and allows them to focus on stock-specific fundamentals, which mans that in theory they should be able to continue to make money even when markets fall.
“It’s a strategy investors have been moving away from during an equity rally, but with markets back t historic highs there’s not so much to be had there.”
“Over the last five years if you played value or growth you would have ended up with a similar result across the strategies and you would have done well in either.”
“Recently, since the summer of 2013, you have more dispersion and stock selection is becoming lower. Lots of managers are saying that they have to be more selective and stock selection is key.”
There is no devoted long/short sector, but funds are mostly lumped in the IMA Targeted Absolute Return sector with multi-asset macro funds such as Standard Life GARS, market neutral funds and other portfolios with differing remits.
Our data shows that the £54m FP Argonaut Absolute Return fund has the best risk-adjusted returns out of the 15 long/short funds we have identified.
Run by FE Alpha Manager Barry Norris, the fund has a Sharpe ratio of 2.14 compared to the 1.89 of the next best figure. The fund has taken on more volatility than the average long short fund, according to our data, but the figure remains extremely low at 7.27 per cent.
In total return it has made 70.57 per cent over three years as the FTSE All Share has made just 30.54 per cent.
Performance of fund vs sector and index over 3yrs
Source: FE Analytics
The fund is currently 58 per cent long and 30.3 per cent short. The largest shorts include UK stocks Standard chartered and Ashmore Group. The fund is currently net long only 30 per cent, which has come down from 60 per cent at its peak last year.
In the market sell off of last year the FTSE All Share lost 10.19 per cent between 22 May and 25 June.
The Argonaut fund lost just 1.83 per cent, although this does put it within the third quartile for the funds under consideration. The fund’s donside volatility is sixth out of the 15 long short funds at 5.62 per cent.
The second best fund in terms of Sharpe ratio is the Henderson European Absolute Return fund, a five FE-crowned portfolio managed by FE Alpha manager John Bennett.
Just £15m in size, the portfolio has returned 40.65 per cent over three years. It is top quartile for downside volatility but in the fourth quartile for returns in last year’s correction, in which it lost 2.96 per cent.
The £951m CF Odey Absolute Return fund has the next best Sharpe ratio, although this fund has a riskier profile.
The fund has returned 92.83 per cent over three years, significantly ahead fo the second-placed Argonaut fund, although with much higher volatility.
Its three-year volatility of 11.78 per cent is slightly lower than its downside volatility of 12.33 per cent, implying it falls more to the downside. Both figures are bottom quartile for lon/short funds.
Source: FE Analytics
One of the problems with comparing the funds in this area is that most have a relatively short track record.
Only BlackRock UK Absolute Alpha has a track record taking in the 2008 market correction. The £268m fund did extremely well in the 2008 crisis but has struggled to generate positive returns in recent years,
Performance of fund versus index over 7yrs
Source: FE Analytics
Younes’ preferred pick in the sector remains the Henderson UK Absolute Return fund, which he highlighted in a recent story on his ISA picks.
The analyst says that the FE Alpha Managers Ben Wallace and Luke Newman are entirely bottom-up driven, meaning that they focus on the merits of the individual companies when deciding which to short or buy.
This process allowed them to outperform in 2008 although the managers didn’t and don’t have a macro view. [The fund was in existence then although not in the IMA sectors.]
Like Norris, they have also been increasing their next short position over the past few months as markets look fairly valued.
Click here to learn more about absolute return investment strategies, with the FE Trustnet guide to absolute return.
