Standard Life Investments Global Absolute Return Strategies (GARS) is by far the most popular UK based fund with investors at £25.4bn – and for good reason. 
Firstly, it is managed by one of the highest-rated teams in the business and invests across all areas of financial markets using around 30 different hedge-fund style absolute return strategies, such as pair trades of different currencies, relative value trades between different sectors and broader allocations to asset classes.
On top of that, it has performed very well. Since its launch in May 2008, the absolute return behemoth has outperformed equities, government bonds and corporate credit with returns of 56.48 per cent.
FE Analytics also shows that Standard Life GARS has had a lower maximum drawdown – which measures the most an investor would have lost if they had bought and sold at the worst possible times – than both equities and corporate bond funds over that time, thanks to its performance during the financial crisis and in falling markets like 2011.
Performance of fund versus sector and indices since launch
Source: FE Analytics
With macro headwinds (such as the potential for higher interest rates in the UK and US, China’s woes and high valuations across financial markets as a result of quantitative easing and ultra-low rates) many experts recommend investors turn to absolute return funds to navigate what is likely to be a tricky few years.
Given it is seen as the default go-to option in the sector, it seems likely that GARS’ popularity is only going to increase. It does, for example, feature on all three of FE’s Adviser Fund Indices and sits on the FE Select 100 list of recommended funds.
However Chris Metcalfe, investment director at iBoss, says investors need to assess other options in the IA Targeted Absolute Return sector.
“I think there is a danger of judging funds on their performance over the last few years,” Metcalfe (pictured) said.
“It is the same with GARS and others like Invesco Perpetual Global Targeted Returns, as no-one knows how all these cross trades will work in a falling market in both bonds and equities – which we think will happen given they have both gone up together thanks to quantitative easing.”
Metcalfe’s major concern, like many industry experts, is that tighter monetary policy in the US and even the UK is likely to cause a painful sell-off in both bond and equity markets. Certainly, correlations between the two asset classes (which have historically moved independently) have increased over recently as yields on government bonds have risen.
Performance of fund versus indices since April 2015
Source: FE Analytics
As the graph above shows, GARS has been unable to shake-off the recent sell-off in bonds and equities.
It was a similar circumstance in May/June 2013 during the notorious ‘taper tantrum’ when the US Federal Reserve warned investors that it would reduce its quantitative easing programme, causing a pan-asset class sell-off.
During the correction, the FTSE All Share lost more than 11 per cent and the Barclays Sterling Gilts index fell 3.89 per cent. As a point of comparison, Standard Life GARS posted losses of 4.71 per cent during the month-long sell-off.
Metcalfe added: “They haven’t done particularly well during smaller sell-offs recently so if you have been looking for a fund to lower your overall drawdown and dampen down volatility, I don’t think GARS has really been doing that job.”
Metcalfe still rates the fund and points out that it has a good track record of smoothing out returns in the past, but he is trying a new tactic going forward by pairing two funds together – namely Premier Defensive Growth and Threadneedle UK Absolute Alpha.
The five crown-rated Premier Defensive Growth fund, which has an AUM of £300m and is headed-up by Paul Smith, is one of the long-only offerings in the sector and has 33.8 per cent in equities, 19.3 per cent in cash and fixed income, 7 per cent property and 32 per cent in ‘other’ assets.
It invests in direct securities and funds and those ‘other’ assets include the likes of BH Macro, Ecofin Power & Water and different synthetic securities.
The fund, which aims to generate positive returns over rolling 12-month periods, has returned 19.28 per cent since its launch in November 2010. While that is lower than the gains from equities, gilts and corporate credit, the fund has been far less volatile and had a much lower maximum drawdown.
The five crown-rated Threadneedle UK Absolute Alpha fund, on the other hand, is a long-short UK equity fund which mainly invests in large and mid-caps.
It has been managed by Chris Kinder and Mark Westwood since its launch in September 2010 and also aims to generate positive returns over rolling 12-month periods. The £442m fund has delivered positive returns in every calendar year since launch, including a gain of 3.8 per cent in 2011 when the European sovereign debt crisis intensified and the FTSE All Share fell 3.5 per cent as a result.
Metcalfe uses a 50/50 split between the two funds within his portfolios and FE Analytics shows the two have complemented each other well in the past.
Since the two funds have been in existence (December 2010), the portfolio has returned 23.95 per cent.
While that is 3 percentage lower than Standard Life GARS’ returns, the composite portfolio has had a lower maximum drawdown, had fewer negative weekly periods, been half as volatile and has generated better risk-adjusted returns (as measured by its Sharpe ratio) than the absolute return behemoth.
Performance of composite portfolio versus fund since Dec 2010
Source: FE Analytics
“Yes it has underperformed on an absolute basis, but its risk-return profile (which the Sharpe captures) is very good and that’s even in market conditions we don’t think have been that favourable,” Metcalfe explained.
Metcalfe is using the Premier and Threadneedle funds due to his concerns about a potential correction in both bond and equity markets and our data shows the combination has worked well when the two asset classes have corrected together over recent years.
For example, since April this year when yields on government bonds spiked, equities fell and GARS posted losses of 0.75 per cent, the composite portfolio posted small gain with a lower maximum drawdown.
It was a similar story during the aforementioned taper tantrum, as the graph below shows.
Performance of composite portfolio versus fund and indices during ‘taper tantrum’
Source: FE Analytics
It must be noted that, since December 2010, the composite portfolio has been highly correlated to equity markets at 0.9, while it has had a negative 0.05 correlation to government bonds. GARS, on the other hand, has had a correlation of 0.55 to equities and 0.18 to gilts over that time.
There is also the concern that, while splitting the two funds equally has worked well in the past, none of the funds mentioned in this article have had to deal with a significant fall in both asset classes.
The likes of Square Mile’s Richard Romer-Lee have therefore said in the past that investors shouldn’t just rely on largely untested absolute return funds.
“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,” Romer-Lee told FE Trustnet said last year.
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.”
Premier Defensive Growth has an ongoing charges figure (OCF) of 0.9 per cent and Threadneedle UK Absolute Alpha is slightly cheaper at 0.89 per cent, but has a performance fee.
