Absolute return funds shot to popularity in the aftermath of the 2008 financial crisis with their stated aim to make a return whether markets are rising or falling. The manager of the 1.4bn Schroder MM Diversity fund says he has become increasingly bearish in the past 12 months, believing the equity market is at risk of correction. He also says he’s struggling to find opportunities in fixed income, forcing him to turn to alternative investment strategies instead.
“We are putting money towards more market neutral products because we are struggling to find managers who are very bearish,” he said.
“In a world where we think fixed income is stretched, and being multi asset investors, there are some pretty difficult implications.”
“One option is to go into a high cash holding, as we have done, and hold bonds as they tend to be negatively correlated [to equities], but this isn’t currently the case.”
“In our alternatives pot we could also have things like property, commodities, hedge funds or currency positions. However, a lot of these areas look fully priced. Our exposure to directional hedge funds is low and we have no property because of the interest rate risk, although we do have some currency positions. “
He says low inflation and an accommodative monetary policy in the US and UK have been helpful tailwinds since the financial crisis but that he expects these two phenomena to tail off, causing the market to lose some value.
“We could even be facing a rising rate environment and an end to QE in the US, in the next six months or so, if not in the next year,” he explained.
“In any case our equity, bond and alternatives look vulnerable.”
“Normally it is the bond part of your portfolio that provides that safety when that leftfield event happens, but we are having to look elsewhere.”
Brookes has been building up positions over the last six months in Morgan Stanley Diversified Alpha Plus, Majedie Tortoise and Schroder UK Absolute Target. The three funds make up a total of 19.42 per cent of the five crown-rated Diversity fund.
The manager says the Morgan Stanley fund has not gone mega-defensive yet, but he notes they have expressed some caution. Majedie Tortoise is definitely becoming more cautious, Brookes says.
“It has reduced its net and gross exposure. It is still not outright bearish but it is a lot more defensive than it was a year ago,” he added.
All three funds have done particular well in the respective sectors over the past year.
The €3.4bn Morgan Stanley Diversified Alpha Plus fund has returned 15.11 per cent over three years beating its sector average, which has lost 1.3 per cent.
Performance of fund and sector over 3yrs
Source: FE Analytics
The Majedie Tortoise fund has also massively outperformed the average fund in its sector, with returns of 39.93 per cent.
Performance of fund and sector over 3yrs
Source: FE Analytics
The Schroder UK Absolute Target fund is managed by two FE Alpha Managers: Steve Cordell and Julie Dean.
It has made a steady return ahead of its IMA Targeted Absolute Return sector average of 7.7 per cent.
However, the gap has started to narrow in recent months.
Performance of fund and sector over 3yrs
Source: FE Analytics
Brookes and co-manager Robin McDonald have been very effective at changing Diversity’s weighting to risk assets. It benefited from switching out of defensives and into cyclical equities in early 2012, and last year its higher cash weighting saw it hold up well during tapering fears in May.
The fund is ahead of its IMA Mixed Investment 20-60% sector and inflation over three and five years, and since its launch in September 2005.
Performance of fund and sector over 3yrs
Source: FE Analytics
Brookes says he still expects to make a positive return in 2014 but is anticipating a much more difficult macro environment.
“It is going to be harder than it has been for the last four or five years and there will be some sort of wobble as a result of high valuations being met with a reduction in monetary accommodation,” he explained.
“QE is being reduced at every Fed meeting and a very public debate about when interest rates are going to rise is occuring.”
“Even Mark Carney – the uber dove – has started to talk about the appropriate levels of monetary policy for what looks like a fairly strong housing recovery in the south east of England.”