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Is there any point holding the likes of Standard Life GARS in your long-term portfolio?

15 December 2015

FE Trustnet investigates whether holding an absolute return fund in a balanced portfolio makes sense over the long term for income investors.

By Daniel Lanyon,

Senior Reporter, FE Trustnet

Investors have not been rewarded with greater income or long term returns by holding an absolute return fund over traditional income vehicles, according to research by FE Trustnet, but have seen an ample reduction in annualised volatility as well as a better overall performance during weak markets.

However, those holding a small exposure to an absolute return fund in a balanced portfolio have not materially missed out on returns while having dampened volatility.

Absolute return funds have soared in popularity in recent years with many investors using them to diversify away from core holdings in equities or bonds.

While there is no ‘absolute’ definition of what constitutes an absolute return fund, generally the idea is to invest broadly across non-traditional asset classes to dampen volatility particular when markets are weak. These could be by using a short selling, futures, options, derivatives, arbitrage, leverage and other unconventional assets.

To test the value of these vehicles, which many state to deliver ‘equity like’ returns over the longer term, in this article we have put together six composite portfolios balancing core equity, fixed income and absolute return funds in varying amounts.

Source: FE Analytics

An important caveat is that there is much less similarity between different absolute return portfolios than say equity income funds, however in this article we feature just one: the £26.4bn Standard Life Investments Global Absolute Return Strategies fund, also known as GARS, given its huge popularity.

Of course the options in picking funds for such an exercise are – nearly - endless and so we have for simplicity chosen just three highly rated funds, including GARS, that have a long track record of more than seven years. They all also happen to be the largest in terms of assets under management in Investment Association universe for each of these asset classes. 

For core equities this means the £12.5bn Invesco Perpetual High Income and for fixed income the £17.4bn M&G Optimal Income funds equally split with a varying mixture of GARS alongside them.

Invesco Perpetual High Income has been managed by FE Alpha Manager Mark Barnett for just under  two years but the strategy of focusing on income producing mega caps in the FTSE All Share is very similar of that of the Neil Woodford, the former manager.

Another FE Alpha Manager Richard Woolnough has run the M&G Optimal Income fund for nine years concentrating on a macro strategy across fixed income markets. GARS was launched in 2008 and has been managed with a team-based approach.


M&G Optimal Income has been the second best performing IA Sterling Strategic Bond fund since Woolnough launched the portfolio in December 2006 with returns of 86.99 per cent.

The fund has also beaten its peers in six out of the last eight calendar years and has been top decile for its risk-adjusted returns, annualised volatility and maximum drawdown since inception. The only portfolio do so in the sector.

Since Barnett took over the Invesco Perpetual in March 2014 following the departure of Woodford, it has comfortably outperformed the FTSE All Share and the IA UK All Companies as well the fund’s former peer group the IA UK Equity Income sector.

Also the manager (pictured) has a longer term track record going back to January 2006 on his £1bn Invesco Perpetual UK Strategic Income fund, with the fund more than doubling the gain of the FTSE All Share over that time.

According to FE analytics, the best performing portfolio since the launch of GARS in May 2008 was that that had no absolute return exposure and was simply an equal spilt between bonds and equities.

However, just five per cent exposure to GARS meant returns since this date were just 5 basis points lower while annualised volatility was reduced from 7.54 per cent to 7.41 per cent.

For each additional 10 percentage points exposure to absolute return (starting from 0 per cent to 50 per cent) while the remainder is split equally between bonds and equities, returns on the portfolios fell.

Performance of portfolios and index over 7yrs


Source: FE Analytics

However, while the income paid out of these portfolios is also lower for the portfolios with higher exposure to absolute return (which shouldn’t come as too much of a surprise given GARS historically yielded less than 1 per cent) the total return is not materially lower.

Over this period M&G Optimal Income and Invesco Perpetual High Income have clocked up almost the same return of nearly 80 per cent which is about 25 percentage points ahead of GARS and more than double the FTSE All Share ex ITs index’s gain of 35 per cent over the longest comparable period.


Also volatility has also been lower for the portfolios with a higher weighting to GARS. This has meant risk-adjusted returns have moved lower in tandem with lower exposure to absolute return.

Risk adjusted returns over 7yrs

   

Source: FE Analytics

Ben Willis, head of research at Whitechurch Securities steers away from using absolute return funds when trying to maximise income but says there is a good case for holding the likes of GARS when markets are weak.

“If a portfolio is looking to maximise as much income as possible then GARS doesn't feature but for someone with a more balanced risk profile, holding a blend of equity income, bonds we do hold GARS from a total return point of view - about 5 per cent.” 

“However, we do also hold it with other similar funds such as Invesco Perpetual Global Targeted Returns. We have actually increased our exposure - not just to GARS – but to those kinds of strategies.”

“In the credit crunch risk assets sold off and there was no hiding place. Bond and equities sold off but GARS held out better.”

While our data shows you’d been better by just splitting exposure between bonds and equities over this period – just - as long as you’re willing to accept higher volatility, the picture is altered in shorter term periods of market weakness such as in 2015.

Risk adjusted returns over the past 6 months have been much higher and with lower volatility in the funds with higher exposure to GARS. Year to date the portfolios with the highest exposure to absolute return has been the best performer as it was in 2010.

Performance of risk adjusted returns over 6months


Source: FE Analytics


Also in the period of the financial crisis the portfolio with the largest weighting to GARS recovered the quickest from the market weakness than the other portfolios since the date of launch’s in May 2008.

Performance of portfolios May 2008 to September 2009

 
Source: FE Analytics

Bambos Hambi, manager of Standard Life Investment’s My Folio fund of funds range says he uses GARS to boost long term returns across the risk spectrum.

“The more risk we take, the more we have in GARS, which is counter-intuitive for a lot of people. Most people see GARS as a defensive fund but we use it a growth asset,” he said.

“Why is that? It is looking to generate cash plus 5 per cent over the long term - which is equity-type returns. But it does that with a third to half the volatility of equities. That's always been a cornerstone of our portfolios.”

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.