The latest figures from the Investment Association show IA Targeted Absolute Return has been most popular sector with institutions for the past four months running. In contrast, retail investors have been concentrating on UK equity income, global, property and corporate bond funds.
Despite several equity markets reaching record highs in recent weeks, several clear risks are on the horizon: the end of QE in the US represents a major withdrawal of global liquidity; geo-political crises loom in the form of the Ukraine conflict and the spread of Islamic State in the Middle East; there’s a risk of a ‘Grexit’ from the eurozone; and the UK faces one of the most uncertain general elections in generations.
So given this backdrop, should more investors be following institutions into absolute return funds?
Performance of indices over 3yrs
Source: FE Analytics
Jason Hollands, managing director at Tilney Bestinvest, said: “Many institutional investors have been taking risk off the table in recent months, raising cash levels and moving into more defensive strategies such as absolute return funds, a sign that concerns have been growing of a market correction.”
“Retail investors have exhibited caution in a very different way: by boycotting funds altogether, with the latest Investment Association data showing a huge slump in net fund sales during January.”
Ben Willis, head of research at Whitechurch, says the moves of both retail and institutional investors have been understandable. Indeed, Whitechurch itself has been adding to UK equity income, property and absolute return funds for some time
“With regards to absolute return funds, we have increased exposure within portfolios where there is no income requirement. Again we moved into this position in early 2013 and it was particularly beneficial during the taper tantrum. At present we prefer multi-asset strategies rather than market neutral equity absolute return funds,” he said.
When it comes to retail investors, AXA Wealth head of investing Adrian Lowcock says there is a general need for them to diversify away from mainstream, popular holdings such as UK equity income, which may include absolute return funds.
“Equity income continues to prove to be a popular area for retail investors and its long-term benefits should be recognised,” he said.
“However, it is very important investors diversify their investments and not just focus on UK equity income, which has been the best selling sector nine out of the past 10 months. Investors should consider other assets – even global or regional income funds to ensure they are diversified.”
FE Analytics shows that the £24.2bn Standard Life Investments Global Absolute Return Strategies (GARS) fund remains the most popular fund in the IA Targeted Absolute Return sector.
The fund is popular with analysts: it appears on the FE Research team’s Select 100 list and holds an A rating from Square Mile Investment & Consulting.
Ben Yearsley, head of investment research at Charles Stanley Direct, said: “In terms of absolute return, the only fund that really sells is GARS – retail investors do buy it, probably based on past performance rather than knowing what is going on under the bonnet.”
“The thing to remember with absolute return is that there are no guarantees: you are still relying on the manager to make the right calls to make you money. If you are concerned about this being the top of the market, then cash is your safest bet.”
Performance of fund versus indices since launch
Source: FE Analytics
When asked which absolute return funds they rate highly, Hollands, Willis and Lowcock all nodded to GARS.
The FE Research team said: “This portfolio offers investors a method of benefitting from the complexities of hedge fund-style absolute return strategies. However, it is more conventional at heart than a hedge fund and seeks to derive much of its returns through dynamic asset allocation, much like a large pension fund might do.”
Standard Life Investments GARS has a clean ongoing charges figure (OCF) of 0.89 per cent.
Hollands thinks that retail investors’ continued move towards income-paying assets could prove painful if there is a major adjustment in the yield curve, as bond funds would be hit hard while the equity income portfolios they have favoured could face a “quite aggressive snap” in stocks that have bond-like characteristics.
“For investors who have concerns about equity market valuations, the bond markets offer no respite as this asset class has been more distorted than any other by years of ultra cheap money,” he said.
“Given this, there is a very strong case for investors wanting a low volatility holding in their portfolio to consider targeted absolute return funds instead of traditional fixed income and our more defensive portfolios have allocations to these types of funds.”
Hollands also likes the Invesco Perpetual Global Targeted Returns fund, which was launched in September 2013 by David Millar, Dave Jubb and Richard Batty – who were instrumental in the success of GARS. The fund has had a strong start and coped well during the volatility that was seen in the second half of 2014, although it must be noted that its track record is still short.
Performance of fund versus indices since launch
Source: FE Analytics
The portfolio is managed on a ‘best ideas’ basis, making use of Invesco Perpetual’s range of funds and derivative-based strategies.
It is free to invest anywhere in the world with no asset class constraints. It currently has 27 ideas in play, with recent moves including the closing of a UK versus Switzerland equity strategy and adding Mexican 10-year government bonds to its selective emerging market debt idea.
Invesco Perpetual Global Targeted Returns has clean ongoing charges of 0.87 per cent.
Willis likes the Invesco Perpetual fund but also highlights Paul Smith’s Premier Defensive Growth fund as an “extremely cautious” portfolio that comes into its own when markets are severely tested.
The five FE Crown-rated fund aims to generate a positive return over rolling 12-month periods, seeking returns that are higher than cash deposits but have a lower level of risk than equity markets.
Its portfolio is well diversified, with exposure to UK equities, commercial property, private equity, global utilities and subordinated debt. But despite its defensive positioning, the fund has made a higher return than its average peer since launch in December 2010 – with lower annualised volatility and maximum drawdown.
Premier Defensive Growth has a clean OCF of 0.90 per cent.
Performance of funds versus indices over 3yrs
Source: FE Analytics
Lowcock also highlights FE Alpha Manager Iain Stewart’s Newton Real Return fund as an attractive option. Stewart’s approach focuses on preserving capital in order to ultimately grow it and builds a core portfolio of UK and global equities with corporate bonds.
“The manager takes a long-term view which is taken with this part of the portfolio,” Lowcock said. “Around this core, the fund invests in cash, government bonds and derivatives. This is used to reduce risk and aims to protect capital. The fund’s flexibility and pragmatic manager make this an attractive investment for investors looking to protect capital.”
The fund holds an AA rating from Square Mile, which says it is an “appealing option” for any investor seeking capital preservation and long-term absolute returns.
The firm says the main attractions of the fund are Stewart’s experience and the global thematic approach that has been developed by Newton.
Newton Real Return has a 0.79 per cent clean OCF.