The downturn in markets at the end of last year highlighted the limitations of some absolute return funds when all assets fall at the same time, but there are some uncorrelated strategies in the closed-ended space that could provide some safety, according to Kepler Trust Intelligence.
In December, equities sold off against a backdrop of renewed friction between the US and China over trade and uncertainty caused by the Federal Reserve’s rate-hiking programme. Fears of a potential recession in the US and the end of the cycle added to equity market woes.
While many investors would usually turn to government bonds in such circumstances, there have been few signs that they can provide extra safety.
“Gilts have traditionally been the ‘risk-off’ trade for those nervous about equity markets,” said Kepler Trust Intelligence investment trust analyst Thomas McMahon.
However, McMahon said gilts were likely to lose capital value with recent performance showing that there was “a real danger of investors suffering periods in which both UK equities and bonds sell off”.
As such, the analyst said large multi-asset absolute return funds that investors have been relying on during market downturns “have largely been a disappointment”.
“While there are a number of different types of strategy in that sector, in most cases this has meant investors turning to the global multi-asset macro funds run by Standard Life, Aviva Investors and Invesco,” said McMahon. “After many years of impressive returns, these funds have more recently struggled to live up to their objectives.”
Sector performance vs annualised volatility over 3yrs
Source: FE Analytics
He added: “In the case of [Standard Life Investments’] GARS, returns have been negative for over a year. As such, the confidence that investors previously held in these funds has been dented.”
However, Kepler’s McMahon said with the return of volatility – and more investment opportunities – there may be some scope for these strategies to make gains.
In the meantime, the Kepler Trust Intelligence analyst said there are several closed-ended alternatives that investors could turn to for help protecting their portfolios.
BH Macro
The first two trusts on McMahon’s list are listed feeder funds to hedge fund strategies both run by the same asset manager.
BH Macro is a feeder fund to the Brevan Howard Master Fund, a macroeconomic-focused hedge fund strategy that targets capital growth through a combination of global macro and ‘relative value’ trading strategies.
Last year the fund made a total return of 31.93 per cent, according to data from FE Analytics, while also recording a double-digit rise in net asset value (NAV).
“The NAV returns were a direct consequence of a return of volatility to markets, which the strategy of BH Macro has so far proven itself to be better suited to than that of GARS and co,” said McMahon.
The analyst said the managers look for trades with an asymmetric risk/reward pay-off that may sometimes contradict each other, with each individual trade expected to generate returns rather than hedging exposure.
The sterling version of BH Macro has ongoing charges of 2.72 per cent, is not geared and is currently trading at a premium to NAV of 2.4 per cent, according to data from the Association of Investment Companies (AIC).
Performance of trusts in 2018
Source: FE Analytics
BH Global
The second fund – BH Global – offers investors exposure to the Brevan Howard Multi-Strategy Master Fund, which invests across a range of asset classes decided by a committee responsible for identifying the best investment opportunities.
Currently the master fund has around 45 per cent invested in the direct investment portfolio, which is “essentially an allocation to the traders whose books make up BH Macro” and leads to a high correlation with the other strategy.
“The diversified approach means that the trust has displayed lower volatility than its sister fund and it has produced positive returns in nine of the 10 calendar years since launch,” said the Kepler analyst.
The sterling version of BH Global is currently trading at a discount to NAV of 1.7 per cent, is not geared and has ongoing charges of 1.7 per cent.
Ruffer Investment Company
Ruffer Investment Company is an option for investors wary of hedge funds, said McMahon, offering a more conventional multi-asset strategy.
The trust is overseen by lead manager Hamish Baillie with deputies FE Alpha Manager Steve Russell and Duncan MacInnes.
“Ruffer takes a cash-relative benchmark common to the absolute return and hedge fund sectors, aiming to beat cash without losing money over any 12-month rolling period,” said the analyst. “The trust is, however, more committed to a single view of the world than the Brevan Howard funds, in much the same way that GARS and co are.”
Performance of trust vs sector in 2018
Source: FE Analytics
Last year Ruffer Investment Company was down by 10.98 per cent compared with a loss of 4.81 per cent for its average IT Flexible Investment peer.
According to AIC data, the trust is currently trading at a discount of 3.9 per cent to NAV – its widest since inception and something which McMahon said could appeal to investors who like to play discounts, given its robust discount control mechanism. It is not geared and has ongoing charges of 1.19 per cent.
However, McMahon warned that it was a strategy for the long term and could see further underperformance if its inflation bet takes longer to pay off.
Gabelli Merger Plus+
Finally, the Gabelli Merger Plus+ is a ‘merger arbitrage’ strategy offering uncorrelated returns to equity markets and should rise when interest rates do and, according to McMahon, is “an attractive alternative to bonds in the current environment of struggling equities”.
“It achieves this by investing in agreed mergers, earning the spread between the deal price and the price of the acquired company at the time the deal is struck,” he said.
“One major component of this return is the risk-free rate, so as rates rise absolute returns will rise too. The rest of the return is a risk premium earned for taking the chance that regulators or shareholders will pull the plug on the deal at the last moment.”
As such the strategy is not dependent on market direction with the main risk that deals do not conclude, although deal activity has been strong in recent years due to favourable conditions.
Last year it made a loss of 7.54 per cent although NAV returns were stronger, said the Kepler analyst.
Gabelli Merger Plus+ currently trades at a 12 per cent discount to NAV due to a major investor selling out during thin trading last summer, according to McMahon, who highlighted the less liquid nature of its shares.
It is not geared, has a yield of 5.6 per cent and ongoing charges of 1.26 per cent.