Not everyone shares this pessimism – FE Alpha Manager Richard Buxton is convinced this is merely a pause in a long-term recovery, for example.
However, for those who are concerned about valuations and the risk-aversion in the market it could be time to think of taking some risk out of their portfolios.
Investors’ first port of call in a storm could well be the IMA Targeted Absolute Return sector, and many professional investors have been increasing their weighting to the sector over the past year.
The complication is that the sector is home to a wide number of different strategies with different risk/return profiles, and some are less appropriate for a capital preservation goal.
Many of the high-profile funds in the sector, such as the CF Odey Absolute Return fund, are long/short funds with a reasonably high level of correlation to equity markets.
The latter fund soared away last year, for example, before slumping with the markets in 2014.
Performance of fund versus sector and index since Jan 2013
Source: FE Analytics
While it is a very good fund in its own right, it is probably not the portfolio for those concerned about an equity market correction.
The second problem investors have is that many of the funds in the sector have a relatively short track record. Only 11 of the 71 funds in the sector were launched prior to the 2008 crisis.
Cutting down our horizon to five years gives us 28 funds to choose from, and over that time these portfolios will have seen the 2011 market correction and a tapering induced crisis in 2013.
FE Analytics allows us to look at how the fund has performed specifically in down markets as well as the simple volatility figure.
The data shows that the fund with the lowest maximum drawdown figure – what you could have lost if you had bought and sold at the worst possible times – is the £1.2bn Insight Absolute Insight Equity Market Neutral fund.
This is also the fund with the lowest downside risk, which measures the volatility of a fund’s performance to the downside.
The market neutral approach refers to taking on pair trades in stocks in the same industry, going long one and short the other.
The fund has displayed extremely low volatility all round, although has produced minimal returns.
Performance of fund versus sector and cash
Source: FE Analytics
It is currently going through a bad period, although this amounts to a loss of only 1.4 per cent.
Nonetheless, investors might baulk at a fund that seems to suffer when equities do, even by such a small amount.
One option could be an absolute return bond fund. The £915m Newton Global Dynamic Bond and £269m SWIP Absolute Return Bond have the second and third lowest drawdowns in the sector over five years, and are top 10 for downside risk.
The downside of using these funds is that they may suffer if we see a repeat of last year’s tapering induced sell-off in bonds and equities.
Newton Global Dynamic Bond fell 3.24 per cent during this time as equities also fell, for example.
The SWIP fund did much better during this period, although along with its lower volatility come lower returns: it is actually down 0.08 per cent over the past 12 months and 1.12 per cent over six.
Multi-asset absolute return funds might be the investor’s best bet. These offer diversified strategies and should hopefully be able to protect cash in different circumstances as a result, with the different strategies exposed to different trends.
Those with the best record on the downside in the sector are Henderson MultiManager Absolute Return, Insight Absolute Insight and Premier Liberation Absolute Growth.
All have a fund of funds structure, although the Insight fund is a blend of seven different strategies run by Newton, the owner of Insight, including the market neutral fund.
Insight Absolute Insight was barely affected by the tapering tantrum of last year and has been flat in the most recent sell-off.
However, it has to be said that when markets stumbled in 2011 on fears for the eurozone the fund also had a rough patch, albeit losing just 3.5 per cent to the falls of more like 15 per cent in the markets.
Performance of fund versus equities over 5yrs
Source: FE Analytics
A less well-known option is the £72m Premier Liberation Absolute Growth fund. This fund buys into a number of hedge funds and hard-to find absolute return portfolios.
BNY Mellon Absolute Return Equity, BlackRock European Absolute Return and Jupiter Absolute Return are the three top holdings.
The fund also includes JPM Global Merger Arbitrage, a fund that follows a strategy few retail investors can access, buying the shares companies it thinks will be taken over and shorting those it think will buy them.
It also includes a position in a convertible bond fund from Ferox, which makes money from going long convertible bonds and short the underlying stock. BlueCrest Bluetrend is also a top 10 holding.
The advantage of a fund like this is that it gives diversified exposure to a number of absolute return strategies which should do well in different circumstances.
The £176m Henderson MultiManager Absolute Return does a similar job, although our data shows it has made less money over five years.
Performance of funds over 5yrs
Source: FE Analytics
The fund has much less in hedge funds and more in various fixed interest positions, including ETFs, straight funds and absolute return bond funds. It lost more in last year’s taper tantrum as a result.
The fund also has 11.4 per cent in property and a 2.3 per cent position in a gold ETF.
Out of the multi asset funds that invest directly rather than through other funds Standard Life GARS is the most popular option, and our data shows it comes out favourably against the competition.
Its maximum drawdown over the period is 4.79 per cent, much lower than equities but worse than the average fund in the IMA Sterling Strategic Bond sector.
The reason for this is the fund’s poor performance during the tapering crisis, when the sell-off in multiple asset classes hurt it.
This is a problem if your motivation in holding an absolute return fund is to protect against such events.
In fact, GARS has underperformed the average bond fund in terms of return as well as volatility over the past five years.
The £14m CF Miton Total Return fund has a better record of capital preservation, according to our figures, albeit with much lower returns.
The below table shows annualised downside risk, maximum drawdown and returns for the two funds and the bond sector.
Source: FE Analytics
In terms of maximum drawdown, downside risk and volatility it has outperformed both GARS and the average bond fund, and was less hit during last year’s tapering tantrum.
However, it has returned only 3.56 per cent a year over the time while GARS has made 7.82 per cent and the average bond fund 9.48 per cent.
Few analysts expect the same sort of returns from bonds in the coming years, however.
Given that all the funds under consideration have had bad patches at different times the best option for investors would seem to be diversification, whether that is through a fund of funds structure or blending different funds themselves.
