The manager of the £961m M&G Episode Growth portfolio says risk and reward tend to be directly correlated over the long term, though FE Trustnet research suggests certain managers have been able to deliver strong returns without taking on much in the way of volatility or downside risk.
Past performance is of course not a guide to the future, but here are five open-ended funds that may be of interest for those searching for the seemingly unattainable in investment terms.
All have outperformed UK equities with less volatility than gilts over a seven-year period.
Freehold Income Authorised
In spite of one of the severest global financial crashes of the past 100 years and a very turbulent 2011, most funds that have outperformed the FTSE All Share over the market cycle – seven years in this instance – have been among the most risky.
There are few exceptions, but without doubt the standout example is Nigel Ashfield’s Freehold Authorised Income fund.
The £202m vehicle attempts to provide a secure and stable return primarily through acquiring freehold ground rents, most of which are in some way tied to inflation.
Income makes up the bulk of the returns but Ashfield and co-manager Stephen Daniels have delivered some capital growth along the way. They target a 4.25 per cent yield, though it’s currently closer to 5 per cent.
The reliability of the asset class has seen the fund deliver a positive return in excess of inflation for 21 consecutive years.
Over the current market cycle, the fund has returned 54.32 per cent with hardly any volatility whatsoever, and a max drawdown of 0 per cent.
Performance of fund, sector and index over 7yrs
Source: FE Analytics
There are a few drawbacks however – no fund is perfect after all. The five-crown rated fund owns over 64,000 freeholds, and is therefore very illiquid.
Encouragingly returns were unaffected by the financial crisis and it has £29.8m of cash on its balance sheet to help offset the poor liquidity.
However, it could be at risk in the event of mass redemptions and can only be accessed by investors with a certified financial adviser.
Freehold Income Authorised is a favourite with Neil Shillito, director of SG Wealth Management, who uses across client portfolios.
It has an annual management charge of 1.2 per cent, and a minimum investment of £5,000.
M&G Optimal Income
FE Alpha Manager Richard Woolnough’s M&G Optimal Income fund has been a standout performer in the IMA Strategic Bond sector in recent years.
According to FE data, the fund has returned a healthy 85.15 per cent over seven years, with an annualised volatility of 6.7 per cent – fractionally less than the average IMA UK Gilt portfolio.
Performance of fund, sector and index over 7yrs
Source: FE Analytics
Woolnough has the flexibility to invest across the fixed income universe, using short-term valuation opportunities to hold investment grade and high yield debt, as well as convertibles, preference shares, equities and cash.
Whether Woolnough will be able to keep up this performance is a big question mark.
There are many who fear a sustained bear market for bonds, with JPM’s Bill Eigen recently warning FE Trustnet that it’s a question of when – not if.
The M&G team explained in the same article why they believe fixed interest yields will stay low much longer than many expect, and the likes of Woolnough and Invesco’s Paul Causer repeatedly claim that it will still be possible to eke out decent returns even if yields do rise.
Encouragingly, M&G Optimal Income’s flexibility allowed it to deliver a positive return of over 7 per cent in 2013, even though yields rose in a number of areas. The average gilt fund lost 5.11 per cent over the 12-month period.
One drawback of the fund’s record over the market cycle is a higher max drawdown than gilts –11.61 per cent compared to 7.06 per cent.
The M&G Strategic Corporate Bond fund has returned only slightly less than Optimal Income over seven years and has a lower max drawdown and annualised volatility, though it invests exclusively in corporate bonds and so doesn’t have the same level of flexibility.
Strategic Corporate Bond is cheaper with clean ongoing charges of 0.66 per cent, compared to 0.91 per cent for Optimal Income.
The strong performance of the latter has contributed to mass inflows of late, pushing assets under management (AUM) to over £21bn.
IBOSS’ Chris Metcalfe voiced concerns over multi-billion pound bond funds in a recent FE Trustnet interview.
FP Matterley Regular High Income
A multi-asset fund with an annualised volatility lower than gilts is a difficult task, and one that’s also managed to outstrip the returns of equities over the market cycle is nigh on impossible.
FP Matterley Regular High Income is the exception that proves the rule.
Sitting in the IMA Mixed Investment 0-35% sector, the fund has beaten the FTSE All Share by almost 10 percentage points over seven years, with an annualised volatility of only 4.45 per cent.
The fund also has a marginally lower max drawdown than gilts’ 7.05 per cent.
Performance of fund, sector and index over 7yrs
Source: FE Analytics
FE Alpha Manager Chris Evans targets both income and growth by investing in a mixture of mostly bonds and equities, though he has some exposure to cash and other funds.
Equities currently have a 20 per cent weighting, while government and corporate bonds account for just over 60 per cent.
Asset class weightings have remained relatively stable in recent years, suggesting it’s been stock and sector allocations that have driven such strong risk-adjusted returns.
The five crown rated fund is still very small, with assets of just £64m. It has clean ongoing charges of 0.86 per cent.
Newton Global Dynamic Bond
Given the subject matter, one may expect absolute return funds to feature heavily, but few tick both boxes.
Some such as Insight Absolute Insight have been masters of capital protection but have failed to keep up with markets, while others like CF Odey Absolute Return have returned significantly more than the FTSE, though with a volatility well in excess of gilts.
Others such as Standard Life GARS have performed very strongly, but are yet to achieve a seven-year track record.
One fund in the sector that has beaten the index over the market cycle with an annualised volatility below UK government bonds is Paul Brain’s £940m Newton Global Dynamic Bond fund.
Our data shows it has returned 56.6 per cent over seven years, beating the FTSE All Share by more than 20 percentage points.
Its annualised volatility of 5.72 per cent over the period puts it well behind gilts on this measure.
Performance of funds, sector and index over 7yrs
Source: FE Analytics
The fund has delivered a positive return every calendar year since its launch in 2006 with the exception of 2011, when it lost just 0.13 per cent.
Newton Global Dynamic Bond is a go-anywhere fund, giving Brain more flexibility than a strategic bond manager.
He can use derivatives, though tends to have a long bias, and can invest up to 50 per cent in emerging market sovereigns, high yield and zero-duration T-bills, which are essentially a proxy for cash.
FE Trustnet gave a more detailed picture of how the fund works in a recent article.
It has ongoing charges of 0.68 per cent.
