City Financial Absolute Equity and FP Argonaut Absolute Return are the two equity funds with the largest maximum drawdowns in 2016 so far despite sitting in the IA Targeted Absolute Return sector, according to FE data, as investors could have lost more than 20 per cent in the two long/short vehicles. 
Though most equity markets have made impressive gains year-to-date, it has hardly been a smooth ride for investors.
Indeed, the MSCI AC World index’s gain of 17.75 per cent certainly masks a significantly high level of volatility – whether that be during the continuation of China’s woes earlier in the year, another collapse in the oil price, a move to negative rates in Japan, slowing global growth or the UK’s decision to leave the EU.
Though most equity markets have made impressive gains year-to-date, it has hardly been a smooth ride for investors.
Indeed, the MSCI AC World index’s gain of 17.75 per cent certainly masks a significantly high level of volatility – whether that be during the continuation of China’s woes earlier in the year, another collapse in the oil price, a move to negative rates in Japan, slowing global growth or the UK’s decision to leave the EU.
Data from FE Analytics shows, for example, that while global equities have made close to 20 per cent already this year, if investors had got their timing completely wrong and bought and sold at the worst possible times, they could be sitting on losses of 8 per cent.
This measurement is known as maximum drawdown. Given the rollercoaster ride investors have had to endure already in 2016, we analysed the numbers to see which of the Investment Association’s 1,374 equity-only funds have posted the biggest potential losses.
The IA universe equity funds with the biggest maximum drawdowns in 2016
Source: FE Analytics
The most surprising finding of the study is that the two funds with the largest maximum drawdowns hail from the IA Targeted Absolute Return sector, which is deemed to be one of the most defensive peer groups and the home to many investors who prioritise capital protection.
Of course, the sector is somewhat of a mixed bag and the funds in question have always tended to be among the peer group’s most volatile – but investors in the portfolios will have no doubt been surprised by their performance profiles.
Sitting at the top of the list with the largest potential loss this year with FE Alpha Manager David Crawford’s City Financial Absolute Equity at 25.29 per cent.
It is a long/short UK equity fund and, up until recently, had been performing exceedingly well.
In fact, it returned 32 per cent in the rallying market of 2013, 20.92 per cent in 2014 when the rally stuttered considerably and was the best performing UK-orientated equity fund in 2015 with returns of 22.66 per cent when Crawford successfully shorted commodity-related stocks and went long domestic-facing mid-caps.
Though that trade was almost spot on last year, drivers behind 2016’s conditions have been completely reversed with the likes of large-cap miners and oil stocks witnessing a significant rebound while the FTSE 250 has been hit hard due to Brexit concerns.
Crawford admits a number of his stock calls (such as being long mid-caps and banks but being short mining stocks) have hindered the performance thanks to the shock EU referendum result.
Indeed, he has since looked to change his portfolio and says he has learned a number of valuable lessons.
Performance of fund versus index in 2016
Source: FE Analytics
“We had already started to reduce risk in the fund – events allowed us to adjust our gross and net positioning, plus reinvigorate and concentrate some of our fundamental views,” Crawford said in his most recent note to investors.
“These changes should help the fund move more on stock specific news and less on macro themes. What lessons have we learned from the drawdown? We think there is a lesson to be learned around being more proactive with risk reduction and enhancements have been made to make this more systematic.”
“All our positions are bottom-up stock specific, but over the last six months we have held a number of correlated positions (short oils, short gold miners, long financials) that effectively ‘all face the same way’.”
City Financial Absolute Equity, which has still beaten the FTSE All Share by more than 2.5 times since its launch in March 2008, has lost 18.95 per cent year-to-date compared to a 7 per cent gain from the wider UK equity market.
While its maximum drawdown has been slightly lower than the City Financial fund (21.91 per cent, ranking it second on the list), FE Alpha Manager Barry Norris’ FP Argonaut Absolute Return fund has posted a greater overall loss of 20.37 per cent.
Again, like Crawford’s fund, the £352m portfolio has performed well over the longer term having made a positive return in every calendar year since launch – including 2011, when the European sovereign debt crisis intensified.
That year the fund, which purely focuses on European equities via a long/short strategy, made 5 per cent.
Performance of fund versus index in 2016
Source: FE Analytics
However, the fund has had a disastrous 2016 so far and Norris – along with co-manager Greg Bennett – says it has been the portfolio’s positioning heading into the EU referendum.
“Brexit has changed everything and our failure to anticipate it cost the fund a significant monthly drawdown,” Norris said.
“The domestic economic recovery in Europe which has been a source of positive earnings upside (and investment performance) for the past few years is therefore now at best uncertain.”
“Macroeconomic inflection points such as Brexit are dangerous moments for any extrapolation of existing bottom-up fundamental trends. We are now anticipating a sea-change in corporate earnings in the weeks and months ahead and have begun to re-position the portfolio for fresh opportunities accordingly.”
Outside of the two absolute return funds, the list of is dominated by portfolios that are heavily biased towards Japanese equities thanks to actions from the Bank of Japan such as the surprise rate cut in interest rates – as well as a general distaste towards the region among international investors.
These include Neptune Japan Opportunities (which has had a maximum drawdown of 19.93 per cent following manager Chris Taylor’s so far incorrect currency calls), Neptune Global Smaller Companies (which is 44 per cent weighted to Japan) and Polar Capital Japan Alpha.
However, while the latter has posted a maximum drawdown of 20.79 per cent in 2016 so year, it has now posted a gain over the year-to-date following significant yen strength relative to the plummeting pound.
Two biotechnology fund also feature (AXA Framlington Biotech and Pictet Biotech) after the previously top-performing market area was hit hard during 2016’s early market volatility and general ‘flight to safety’.
JPM Turkey Equity completes the list, which isn’t hugely surprising last months failed military coup against the government.
Performance of fund versus index in 2016
Source: FE Analytics
Its maximum drawdown has been 17.08 per cent, but due to the fact it was actually outperforming global equities prior to the coup attempt, it is stilling sitting on a return of 12.10 per cent over 2016 as a whole.
