The losses suffered by Standard Life Investments Global Absolute Return Strategies over 2016 have been caused in part by a rise in short-termism in financial markets, according to the team behind the behemoth portfolio.
In an update to investors, the managers of the £26.4bn fund highlighted the reasons for its underperformance over the past nine months and conceded that its loss of more than 3.8 per cent since the start of the year have “fallen short of the level we expect over the long term”.
As the chart below shows, the fund – which is often known as ‘GARS’ – has lagged the returns made by its average peer and its benchmark. It is also significantly behind global equities and bonds although it is not designed to always keep up with these.
Performance of fund vs sector and indices over 2016
Source: FE Analytics
“We choose investments for GARS on the basis of their fundamental long-term (typically three year) return potential. So far in 2016, global investors have displayed significant short-termism, oſten focusing on single data points, creating wild swings in asset markets," the team behind the fund said.
“During three distinct periods in the last year, markets have responded to a variety of factors, including central bank action and concerns over growth. This has led to exceptional demand for government bonds, driving yields on over a third of them into negative territory. With investors relentlessly pursuing income-generating assets, yields globally have become compressed, distorting valuations almost beyond recognition.”
“The series of events that unfolded during the past 12 months differed greatly from our central view and in fact resembled a combination of the ‘tail-risk’ events for which we stress-test the portfolio. In that respect, GARS performed in-line with our expectations. This tells us that risk management and diversification remain sound, with negative returns deriving instead from an unusual and extreme set of market circumstances.”
Over the long term, GARS has a strong track record in generating a steady return and meeting its target of positive returns over rolling three-year periods in any market condition. For example, it has generated a positive return in each of the full calendar years since its retail launch.
However, its team points out that there have been three distinct periods when its returns were below target: in the global financial crisis of 2008/2009, the eurozone debt crisis of 2011 and the past year.
Performance of GARS vs target over 10yrs
Source: Standard Life Investments, GBP gross performance from 12/06/2006 to 31/08/2016. Fund performance is based on the UK institutional pooled pension fund, gross of fees. Target is defined as cash +5 per cent
While the team says “unusual and extreme set of market circumstances” are the reasons behind the recent underperformance, it has made “subtle but material” adjustments to GARS’ portfolio to reflect changes in fundamentals. “We are confident these changes will ensure GARS performs well in this uncertain environment,” it added.
The team’s outlook is that major developed economies are moving a new equilibrium, where long-term growth is lower than in past market cycles.
“Over the past 30 years or so, economies such as the US and Western Europe have been boosted by a variety of tailwinds: efficiency gains from automation, the establishment of global supply chains, declining tax rates, falling inflation and interest rates, as well as burgeoning emerging market demand,” the update said.
“Now, these drivers have either slowed significantly or ended completely. The outlook is further clouded by headwinds, such as high levels of public and private sector debt, as well as the economic and political uncertainty arising from shocks like the UK’s vote to leave the EU.”
The base case has led to a number of changes to the portfolio. GARS’ allocation to equity markets is now low by its historic standards, given the muted growth outlook and extended valuations; within equities, it favours Europe where stronger earnings are expected in 2017.
The fund has also been adding to real estate investment trusts with exposure to geographic areas it favours, such as prime, high-quality real estate in the US. Meanwhile, it has added “substantially” to US, UK and European investment grade bonds, as well as high yield, over the past year.
Other positions include UK interest rates relative to German rates, as the expected weakening of the UK economy is likely to keep the difference between the two narrowing, and various plays in currency markets, such as Indian rupee versus Swiss franc.
“GARS remains a compelling investment proposition,” the team concluded. “The combination of robust diversification and sound long-term investment ideas has generated consistent solid performance for long-term investors. Above all, this reflects a disciplined process and a well-resourced, highly experienced investment team.”
However, GARS was recently removed from the FE Invest Approved list – where it has held a place since the list’s inception in 2012 – following its run of underperformance.
GARS’ 3yr rolling returns
Source: FE Analytics
Explaining the reasons for its “loss of conviction” in the fund, the FE Research team said: “SLI GARS is a global macro thematic fund and investors pay fees to the management team to take views on the global economy. We know that a manager cannot be correct 100 per cent of the time and we do not base our sell decision on being wrongly positioned.”
“The concern here is that the GARS objective is to return cash performance, even if the management team’s views are wrong. They set up offsetting strategies so that the fund could at least return positive performance even if the positioning is miscalculated. When the strategies are in place and effective, the fund should at least be returning cash plus 3 per cent.”
“So far in 2016, the offsetting strategies have failed to work and have failed to prevent losses. This period of underperformance reminds us of the fund’s poor performance during the tapering tantrum of May-June 2013 - where risk management also failed (correlation between asset classes spiked and diversification benefits faded).”
In a coming article, we will take a closer look at the absolute return fund that FE Research now favours over GARS.