On the face of it absolute return funds have had a very good couple of years, with the vast majority delivering a positive return in both 2012 and 2013. However, Younes says it’s crucial to put this performance into context, warning investors that these same vehicles are susceptible to a major correction if markets turn south. “We’ve had a very strong period for equity markets, and typically absolute return funds find it easier to achieve their objectives in this environment,” said Younes (pictured).
“If you look at their record during falling markets such as 2011 and 2008, they found it much more difficult, with only 24 out of 56 achieving a positive return in 2011, for example.”
“Investors buy absolute return funds to protect their capital, and so it’s during down markets that they really show their worth. Buying one that’s a top performer over a three or even a five year period is dangerous, as there’s a very good chance the funds in question have a high correlation to the equity market, and a high volatility.”
Over the past three years, eight absolute return funds have managed more than the 30.54 per cent return of the FTSE All Share. Three of these – CF Odey Absolute Return, City Financial UK Equity and FP Argonaut Absolute Return – have managed more than 50 per cent. The Odey fund has managed an incredible 92.83 per cent over the period.
Only five of the 58 funds in the sector with a long enough track record over the period have failed to break even.
Risk/return of absolute return funds and FTSE All Share over 2yrs
Source: FE Analytics
A number of the top-performing funds over this period, including Odey, are long/short equity funds, with a high annualised volatility even compared to the FTSE All Share.
Younes points out the fund has a correlation of 0.67 to the FTSE All Share over three years, which is relatively high for an absolute return portfolio, and has an only slightly lower annualised volatility than the index over the period.
Its max drawdown – which measures how much an investor would lose if they bought and sold it at the worst possible time – over the period is over 16.19 per cent, which is higher than the FTSE All Share’s 15.94 per cent. This was thanks to a steep loss at the culmination of the eurozone crisis in 2011.
Younes is keen to point out the strengths of the fund, but says regular absolute returns investors should probably look elsewhere.
“The fund has benefited very well from the manager taking more risk at the right time; however, for investors looking for something to protect their capital from downside risks, I think there are better examples,” he said.
“The key is to find an absolute return fund that has a low correlation to equities and bonds, so that they’re not subject to sudden movements in the markets. Funds with a proven track record of protecting capital, measured by the max drawdown, is also very important, as is a low annualised volatility.”
Looking at these measures, he flags up the Henderson UK Absolute Return fund, which has been recently added to the FE Select 100 – a list of funds recommended by the FE Research team.
He said: “The manager Ben Wallace also uses a long/short process, but has operated with significantly lower risk. It is among the fund’s that has returned more than 30 per cent over the last three years, but has a max drawdown of just 5 per cent over three years and a low annualised volatility.”
“He manages two core portfolios within the strategy – one with a long-term view of companies, and another which looks to take advantage of short-term price inefficiencies.
The team also rates the Insight Absolute Insight fund highly. The £626m portfolio, which is headed up by FE Alpha Manager Reza Vishkai, has a max drawdown of just 3.55 per cent over three years. It hasn’t returned anyway near as much as the Odey fund over the period, but for a cautious investor with a short time horizon, the FE Research team rates it as a strong contender.
Performance of funds vs index over 3yrs
Source: FE Analytics
“The risk/return profile of the fund may look boring, but this is exactly what its managers are aiming for: to provide small but regular returns, minimise volatility and preserve investors’ capital,” the team said.