Absolute return funds jumped in popularity with UK retail investors last month after a series of headwinds dampened confidence, so where should they be looking if they expect equity and bond market turmoil to resume?
The sentiment of investors across the globe has taken a hit in recent weeks on the back of the steep fall in the Chinese stock market, concerns over the health of the global economy and the likelihood that the Federal Reserve will start to lift interest rates before the year is out.
According to the latest State Street Investor Confidence Index (ICI), which measures investor confidence or risk appetite quantitatively by analysing the buying and selling patterns of institutional investors, shows a market fall in sentiment over the course of July.
The Global ICI decreased to 114.6 points, down 12.5 points from June’s revised reading of 127.1, while the European ICI, which includes UK investors, dropped 2.1 points to 100.4.
State Street Global Exchange chief innovation officer Jessica Donohue said: “The rollercoaster ride across China's equity markets and the absence of a definitive Greek bail-out agreement has certainly weighed heavily on risk appetite.”
“While the aggressive response of the Chinese authorities to calm investors nerves seems to have had a net positive affect on sentiment within the region in the month to 22 July, the continued volatility in equity markets highlights how temporary such measures can be.”
It seems that sentiment among retail investors has also taken a dip, as the latest figures from the Investment Association shows the IA Targeted Absolute Return sector was the best-selling peer group in June. Net retail sales of £445m saw the sector move from second place to first, pushing IA UK Equity Income down one spot.
Investment Association chief executive Daniel Godfrey said: “Net retail sales held up well in June despite the uncertainty surrounding the Greek bailout and Chinese markets.”
“Most striking was mixed asset funds having their best month since last summer and Targeted Absolute Return funds being the most popular sector as many investors left it to fund managers to decide on asset allocation in uncertain markets.”
FE Analytics shows Invesco Perpetual Global Targeted Returns was the most popular fund in the peer group during the month, with inflows of £743m pushing its total assets to just under £2.4bn. The fund, which was launched in September 2013, has proven popular with analysts and fund buyers, despite a recent dip in performance.
Performance of fund vs sector and indices since launch
Source: FE Analytics
Other popular products, according to our data, included Threadneedle UK Absolute Alpha, Henderson UK Absolute Return and Newton Global Dynamic Bond.
When it comes to choosing a fund, the sector presents investors with a confusing array of options as it includes equity-focused products that aim for higher returns but come with more volatility to those that offer a very smooth ride but limited prospects for significant gains.
Adding to the dilemma, many of the funds in the sector were launched after the global financial crisis – meaning they are untested in the type of severe bear market that their investors hope they will protect them from.
Over the past eight years since the onset of the financial crisis, the fund with the lowest maximum drawdown – which measures the most an investor would have lost if they had bought and sold at the worst possible times – has been Insight Absolute Insight at just 3.08 per cent; over this time the FTSE All Share’s maximum drawdown was 41.09 per cent while Barclays Sterling Gilts’ was 5.98 per cent.
The four crown-rated fund, which is a member of the FE Research team’s Select 100 list, targets incremental but steady returns while minimising losses through investing in a handful of funds managed by Insight – such as their Equity Market Neutral, Credit, Currency and Liquidity funds.
As the below graph shows, Insight Absolute Insight produces a very smooth return profile (its annualised volatility over the past eight years is the sector’s second lowest at 2.35 per cent) and has managed to beat its average peer; however, its total return is far below that offered by the All Share and gilts over the market cycle.
Performance of fund vs sector and indices over 8yrs
Source: FE Analytics
The FE Research team said: “The risk/return profile of the fund may look boring, but this is exactly what its managers are aiming for: to provide small but regular positive returns, minimise volatility and preserve investors’ capital.”
Over the eight-year period in question, the fund with the lowest annualised volatility has been RWC Core Plus at 1.84 per cent.
This fund invests the bulk of its portfolio in convertible bonds, along with complementary asset classes and derivative exposure, with aim of achieving “strong positive returns” over rolling three-year periods with low volatility.
Although many investors are cautious about the outlook for fixed income, given the Federal Reserve is soon expected to lift interest rates, convertible bonds have had historically low correlations with traditional bond markets and tend to do well in a rising rate environment.
RWC Core Plus’ low volatility may prove reassuring to very cautious investors, but this quality is also reflected in its total return. Over eight years it’s up just 12.19 per cent – less than half the return of its average peer and well below the All Share’s 48.39 per cent and gilts’ 67.20 per cent.
Performance of fund vs sector and indices over 8yrs
Source: FE Analytics
While the above funds may have too tame a return profile for some investors, analysts have highlighted other products that offer the prospect of higher returns along with risk-limiting approaches.
Along with Insight Absolute Insight, the £26bn Standard Life Investments Global Absolute Return Strategies fund is another member of the Select 100, thanks strong long-term track record.
The fund was launched to retail investors in the midst of the global financial crisis and has had difficult periods, such as in 2008 and June 2013 when asset classes fell together. However, the FE Research team notes that losses were made back relatively quickly, adding that “risk management is in the DNA of the fund”.
Henderson UK Absolute Return, which focuses on the UK equity market, is the final absolute return fund on the Select 100. Our analysts say it could be a good option “an investor who wants to invest in the stock market while limiting risk”, as its ability to short stocks has allowed it to limit losses in falling markets.
“The current environment is difficult for this strategy: it is hard to value many companies given the importance of central bank policy for their future performance,” FE Research said.
“The fund will likely do better if the economy improves, interest rates rise and the focus shifts back onto company earnings. Nonetheless, the ability to ‘go short’ should mean it can smooth returns for investors in the bad times as it has in the past.”
Performance of funds vs sector and indices over 5yrs
Source: FE Analytics
Square Mile Investment Consulting & Research also give the Newton Real Return and Jupiter Strategic Reserve funds an ‘AA’ rating.
The mantra of the £9.5bn Newton Real Return fund revolves around the principle that the main risk to any investment is the permanent loss of capital, while short-term volatility should be a secondary consideration if the underlying investment case for an asset remains sound. This means it can be more volatile than its average peer but has a good track record of outperformance.
Jupiter Strategic Reserve, on the other hand, is focused on minimising losses and the manager would rather be too cautious than put too much risk in the portfolio. Square Mile said: “The manager has an impressive record of maintaining investors' capital over a number of market crises in the last 15 years. This is testament to his cautious approach and the well-crafted portfolio construction.”
