Nearly two-thirds of funds in the IA Targeted Absolute Return sector have failed to beat cash for returns over the past three years, according to data from FE Trustnet.
Absolute return funds have exploded in popularity in recent years and among those to see the greatest inflows are the likes of Standard Life Investments Global Absolute Return, or GARS, which now the the largest portfolio in the whole Investment Association universe with total assets of £26.1bn.
Cash has flowed into the sector on such a huge scale as investors looked to diversify risk after the strong gains made in the bull run between 2009 and 2013, especially following the European sovereign debt crisis of 2011 bringing the spectre of cyclical weakness sharply into focus.
Funds offering an ‘absolute return’ normally employ a range of hedge fund-style strategies in order to provide a rolling three-year return that betters cash.
This could be anything from holding direct equities or bonds to complex and esoteric derivative securities or currencies. The idea is to buy lots of uncorrelated risk assets based on a very broad base of potential macroeconomic outcomes, so returns will be lower but more likely to stay in positive territory in a range of market conditions.
However, just holding cash in the best available Individual Savings Account [ISA] three years ago would have provided a better return more often than not in the IA Targeted Absolute Return sector.
The best three-year fixed rate cash ISA back in 2012 was the Halifax ISA Saver Fixed, where it’s 4.25 per cent per year would have resulted in a 13.29 per cent total return today if you’d put the cash in in September 2012. It had a minimum of £500 deposit, about the same as a typical retail fund.
Source: FE Trustnet research/ FE Analytics
It must be said, of course, that the IA Targeted Absolute Return sector is a collection of very different funds with objectives. Some target more aggressive growth and only invest in stocks while others aim for very steady, but generally lower, returns.
Nonetheless, comparing our data on the returns of all the funds with a three-year track record in the sector and the return an investor would have received from a cash ISA since 2012, we can see that an overwhelming 40 out of 63 funds made less than cash’s 13.29 per cent.
Some of the most well-known within these 40 funds include the likes of Newton Real Return (8.03 per cent), Jupiter Absolute Return (5.08 per cent), Absolute Insight Equity Market Neutral (6.84 per cent) and Kames UK Equity Absolute Return (10.76 per cent).
Ben Willis, head of research at Whitechurch Securities, says the reason for the underperformance could be several disparate trends.
"Although it is a mixed bag of a sector, what you tend to find is some of the market neutral funds find it difficult when there has been a lack of volatility, especially if market movements have been driven by investor sentiment. This have very much been the case over the past three years," he said.
"On the multi-asset side you could say that bonds have had pockets where they have come under pressure. Some of the macro calls have not been panning out because markets have been driven a lot by either headline news on a day-to-day basis or sentiment."
“But of course a lot of these funds are benchmarked against cash over a three-year period and so with it being so low, it is quite hard to defend when they haven't done that.”
But this does not mean there aren’t good options for investors to look at in the sector.
Standard Life Investments’ £26bn GARS fund is arguably the best known absolute return fund in the IA universe. It is also hugely popular outside, with further private mandates that bring its total strategy to more than £40bn in size. Some have said its ubiquity makes it the ‘iPhone’ of the funds industry.
It has beaten the best cash ISA return over three years, but by just 0.31 per cent, with a total return of 13.6 per cent versus a sector average of 12.49 per cent.
Performance of fund, sector and index over three years
Source: FE Analytics
FE Research fund analyst Charles Younes says cash is a good assessor of an absolute return fund’s performance over a three-year period but their relative value of such a period is more complicated.
“Absolute return funds generally make a number of macro calls that are not often relate to cash so how they fit into a portfolio is different,” he said.
“Despite cash being a good assessor of an absolute return fund’s performance, it does not explain how a fund should behave within a portfolio. Due to their complex strategies, the drivers of the performance are very different and not necessarily directly linked to cash.”
“As a result, due diligence must cover this in order to understand how the absolute return fund will fit into a portfolio.”
Tilney Bestinvest’s Jason Hollands (pictured) is a fan of absolute return funds, believing they can provide some protection in the event of the unexpected, which he says is more relevant in the recent future than it was in the recent past.
"During the boom years of asset price inflation, investors have been rewarded for being long equities,” he said.
“However, with elevated levels of volatility and the potential for greater divergence between central bank policies, investors should revaluate the case for holding funds with toolkits for investing across asset classes, markets and currencies with the goal of generating absolute returns across market environments.”
Hollands says one of those he backs include the £2.9bn Invesco Perpetual Global Targeted Returns fund, which being launched in September 2013 is not included in this study.
Invesco Perpetual hired ex-GARS team members David Millar, Dave Jubb and Richard Batty from Standard Life Investments to launch the fund.
Since launch it has returned 12.36 per cent, while GARS has returned 10.27 per cent and the sector’s 6.97 per cent.
Performance of funds and sector since launch
Source: FE Analytics
The Invesco Perpetual Global Targeted Returns fund also scores lower volatility than GARS – 4.12 per cent compared to 4.4 per cent – which was about a third of the volatility of the FTSE All Share which was 12.47 per cent.