Investors seem to want more cautious funds for their portfolio as research by Square Mile, a strategic partner of FE, shows the IMA Targeted Absolute Return sector has been the most searched IMA peer group on its website since its launch earlier this year.
Given some of the recent outlooks for both bonds and equities reported here on FE Trustnet, it is understandable why so many investors are looking for a surer form of protection.
Many have warned that now QE has ended in the US, as economic growth is still relatively weak and disproportionally spread and as – apart from 2011 – investors have seen uninterrupted gains since the crash, we should expect lower returns and greater volatility from equity markets going forward.
At the same time, now that the US Federal Reserve has stopped piling $85bn a month into the market and as interest rates are expected to gradually rise, some managers – such as JPM’s Bill Eigen – have said there will be devastation in the bond market over the coming years.
However, while many have been upping their exposure to absolute return funds, data from FE Analytics shows 71 per cent of funds within the sector were launched since the market bottomed in March 2009 after the financial crisis – and have therefore only generally dealt with a rising market.
Those include the £5.2bn Ignis Absolute Return Government Bond fund, the £1.5bn Carmignac Capital Plus fund, the £1.4bn Old Mutual Global Equity Absolute Return fund and the £910m CF Odey Absolute Return fund.
Richard Romer-Lee (pictured), managing director at Square Mile, is concerned that a growing number of retail investors are turning to absolute return funds which, as yet, have not witnessed a “messy bear market”.
“What we have seen since [the crash] is a lot of the retail focused asset managers started to invest in risk systems and in fund managers with the right experience in creating a different range of outcomes in the alternative or absolute return world,” Romer-Lee said.
“We’ve seen lots of strategies launched since then which haven’t really been tested and when the doomsday comes it will be interesting to see how many of those do well and how many of them can give you an acceptable asymmetry of risk.”
He added: “On average, it’s like any sector, some of them are really good, some are not and quite a lot of them are unproven.”
One portfolio he throws into the “unproven” camp is the Standard Life Investments Global Absolute Return (GARS) fund, which is the sector’s behemoth with its AUM of £23bn, even though it was launched in May 2008 and therefore had to deal with Lehman Brothers’ induced crash and its aftermath.
Speaking to FE Trustnet earlier in the year, Romer-Lee said: “Is [its size] because Standard Life Investments have executed an investment strategy very well? They have and it's helped but that's not the sole reason. Is it because they are very good at distributing funds? Yes, that's probably helped too,” he said.
“Is it because they have offered something people need and where there's a dearth of supply? Absolutely. But it's still early days in the retail market for capital preservation funds."
"In the great scheme of absolute return or capital preservation investing it's very early days in the mutual fund market."
According to FE Analytics, Standard Life GARS has gained 50.66 per cent since its launch and our data shows those returns have been lowly correlated to both bonds and equities.
Performance of fund vs indices since May 2008
Source: FE Analytics
Its maximum drawdown since launch, which measures how much an investor would lose if they bought and sold at the worst possible time, at 12 per cent is more than three times lower than the FTSE All Share’s though twice as high as the iBoxx Sterling Gilt All Maturities index’s.
However, Romer-Lee argues that the fund hasn’t had to operate in conditions where both the bond and equity markets go through a prolonged downturn – which some have warned could happen as central bankers tighten monetary policy.
“[Standard Life] have invested a lot of money in the different risk systems and they are in a bigger group so they will tell that they have access to all these ideas, but it hasn’t really been tested yet as we haven’t seen a really messy bear market,” he said.
One, although short term, messy phase that GARS has witnessed was in May/June last year during the “taper tantrum” – when the Fed announced it was looking to reduce its QE programme which caused bonds, equities and commodities to fall in value.
According to FE Analytics, like both bonds and equities, Standard Life GARS fell losing 4.71 per cent, underperforming against the sector.
Performance of fund vs sector and indices during the “taper tantrum”
Source: FE Analytics
However, the caveat to that is that Standard Life GARS’ objective is to “target a level of return over rolling three-year periods equivalent to cash plus five percent a year, gross of fees” and therefore highlighting one negative month is a tad unfair.
Nevertheless, Romer-Lee says investors must be very careful when they choose funds that can offer a genuinely uncorrelated return to other asset class and one which can genuinely deliver absolute return.
He and his team have therefore not awarded any funds for a “capital preservation” outcome with their highest AAA-rating.
"They've only really started offering funds like that in the last six or seven years and that's not really long enough to build the highest level of conviction in their ability to deliver those [capital preservation] objectives throughout market cycles.”
“We've only lived through half a market cycle since 2008, maybe two-thirds.”
One fund he does like is FE Alpha Manager Iain Stewart’s £9bn Newton Real Return fund.
Stewart has managed the fund since March 2004 and our data shows it has returned 128 per cent over that time, significantly beating its benchmark of cash plus 4 per cent.
Performance of fund vs indices since Mar 2004
Source: FE Analytics
That return is slightly lower than the FTSE All Share’s gain but it has been considerably less volatile and has had a much lower maximum drawdown. Though it has outperformed gilts, it has given investors more of a bumpy ride.
However, the fund has made a positive return in nine out of the last 10 calendar years – the exception being 2011 when it fell 0.75 per cent – and that includes a 4 per cent gain in the crash year of 2008.
The fund sits on the FE Select 100 and invests across equities, bonds and gold and hedges via derivatives to dampen down overall portfolio volatility.
FE Research’s Amandine Thierree says Newton Real Return suits investors who are willing to invest for three years, want to protect capital and are looking to diversify their portfolio.
“The fund’s main features make it suitable as a core holding in any portfolio: it invests in the main asset classes, regardless of location, and it aims to beat cash once inflation is taken into account,” Thierre said.
It yields 2.8 per cent and has an ongoing charges figure (OCF) of 1.11 per cent.
