Risks across both the equity and bond markets have put the emphasis back on capital protection, according to Insight’s Sonja Uys (pictured), who believes that absolute return funds are likely to benefit as a result.
Both equities and bonds have had a stellar five year period, thanks in no small part to central banks’ quantitative easing programmes. However, the manager of the £676m1 Absolute Insight fund says the fact that QE has been tapered in the US, combined with expensive valuations across the board, means that investors may now want to be focused more on protecting themselves.
“Bond yields are almost back at 2008 levels, and at the same time equity valuations have been very high and pricing in a certain level of earnings that we haven’t seen substantiated yet,” she explained.
“We’ve seen negative earnings revisions this quarter, but still the market is going up.”
Performance of indices over 5yrs
Source: FE Analytics. Past performance is not a guide to future performance.
“I think now is the time to be wary, as there is the possibility of a correction.”
Absolute Insight is a multi-strategy fund, invested in six absolute return portfolios under the management of Insight Investment. Uys explains that the manager of the Absolute Insight Credit Fund Alex Veroude has been buying derivative strategies2 to help protect his fund from a possible correction.
“A correction in equities is what could trigger a correction in the bond market,” she added.
Uys believes that many investors have failed to learn the lessons of 2008, shown by the oversubscribing of low quality bonds with a relatively low yield.
She says that none of the managers of her underlying holdings participated in the recent Greek government debt auction, arguing that the risk/reward profile is unattractive.
“You’re seeing some pretty dodgy companies offering yields at ridiculously low levels,” she said. “We can benefit from this by shorting specific single names.”
By going ‘short’ on a stock, fund managers are able to make money from falling share prices.
One of the few areas Uys sees genuine value in the bond market is RMBS – residential mortgage backed securities.
“Many people are worried about getting into this part of the market, but Insight’s expertise allows us to do so with confidence,” she said.
Uys explains that the managers of the six underlying portfolios –Absolute Insight Equity Market Neutral, Currency, Credit, Emerging Market Debt, Dynamic Opportunities and BNY Mellon Absolute Return Equity – are given total control over the running of their funds, but doing so within a very clearly defined risk framework.
“They are experts in their field and giving them full discretion allows them to act quickly when having to adjust their portfolios to fast changing markets. I sit on the investment committee which tries to ensure that the risks of the underlying strategies stay within their set frameworks, but the day-to-day running is up to them.”
Equity Market Neutral, Currency, Credit and Emerging Market Debt make up approximately 84% of assets, with BNY Mellon Absolute Return Equity and Absolute Insight Funds Dynamic Opportunities accounting for around 8 per cent apiece. Uys and co-manager Reza Vishkai also have a very small weighting to cash.
The weightings to these portfolios seldom change, with the managers only making big shifts in extreme circumstances.
“They are all complimentary to one another and have a low correlation to equities and bonds,” she added.
The performance of Absolute Insight has been very strong from a risk-adjusted return point of view. FE data shows it has delivered a positive return in five of the last six calendar years, only losing 0.17 per cent in 2008.
Performance of fund, sector and indices since Feb 2007
Source: FE Analytics. Past performance is not a guide to future performance.
The fund is consistently one of the least volatile in its sector, and has beaten its peers as well cash and inflation over one, three and five years, and since its launch in 2007.
A number of funds in the Targeted Absolute Return sector have vastly outperformed Absolute Insight in recent years.
Uys says that investors need to remember why they’re holding absolute return funds in the first place, before criticising funds for not participating in rising markets.
“If the markets go up we are likely to underperform,” she explained.
“You need to judge an absolute return fund on the aims of the manager before you buy it. In the case of Absolute Insight Fund, we seek low volatility and capital preservation.”
“May and June of last year was a great test. Equities and bonds sold off at the same time which is unusual, but our fund was positive over the period.”
“The same was true in 2011 during the eurozone crisis. This is when your absolute return fund needs to come into its own.”
While the underlying funds in Absolute Insight are generally low volatility, Uys says that the more directional strategies will still have targeted exposure to certain themes within their respective universes. For example, the credit fund has a long bias to asset backed securities and financial bonds, while Dynamic Opportunities is long Spanish bonds and short German bunds.
She says the Dynamic Opportunities Fund has recently closed its negative view on Chinese equities, but they are not getting carried away.
“We still think there will be a slowdown, but policy measures to increase domestic consumption should be constructive,” she said.
“This month the government has been encouraging banks to lend to small businesses. In the shorter-term, we see some upside.”
Emerging market debt had a terrible time of late, but Uys points out that the Insight Emerging Market Debt fund was flat over 2013. She says that the general sell-off has created opportunities in certain markets, with Indonesia being a good example. They remain short Russian government debt, however.
1 – As at 30 April 2014.
2 – Derivatives are a financial product, the value of which is based on something else (like the price of gold or the shares in a specific company); as such it can be used to link to a wide variety of assets or combinations of circumstances. For example, if a fund manager believes the share price of company ABC will fall in value over six months, he can buy a derivative that will pay if it does so. This potentially enables the manager to make money if a share price falls.
This article is sponsored by BNY Mellon Investment Management. For a guide to absolute return investing, click here.
Past performance is not a guide to future performance. The value of investments and the income from them is not guaranteed and can fall as well as rise due to stock market and currency movements. When you sell your investment you may get back less than you originally invested. You should read the Prospectus and Key Investor Information Document (KIID) for each fund which you want to invest. The Prospectus and KIID can be found at www.bnymellonim.co.uk.