Absolute return funds managed to avoid some for the falls that blighted equity markets in 2018 but it’s not all good news: they lagged behind government bonds when it comes to diversifying portfolios – and some of the biggest names in the space fell short by a wide margin.
Absolute return funds have endured a rough patch over the past few years after the underperformance of some of the sector’s largest names and the argument that these complex strategies are not necessary in the average investor’s portfolio.
FE Analytics shows the average member of the IA Targeted Absolute Return sector made a total return of just 1.54 per cent over the three years to the end of 2018, compared with a gain of more than 40 per cent for global equities and a double-digit rise in gilts.
Performance of sector vs index over 3yrs
Source: FE Analytics
Adrian Lowcock, head of personal investing at Willis Owen, said: “Absolute return funds have struggled over the past few years. Partly, this is natural as we have been in a bull market and partly it is due to calls that have not worked out as expected. However, some funds have done better than others and it is hard to group them all together.”
Last year may offer some justification for absolute return funds, though, after equity markets were rocked by tighter monetary policy, global trade tensions and concerns over slowing economic growth.
Our data shows that the average IA Targeted Absolute Return fund fell 2.81 per cent in 2018, against drops of 3.79 per cent in the MSCI AC World and 9.47 per cent in the FTSE All Share.
However, the sector underperformed gilts, which rose by 0.50 per cent in total return terms, and – as we will see – some of the best-known funds in the peer group fell harder than global equities.
The final quarter of 2018 was an especially difficult one for markets, with sell-offs being encountered in October and December. The MSCI AC World and the FTSE All Share both dropped by just over 10 per cent over the three-month period, but the average IA Targeted Absolute Return fund was only down by 2.34 per cent.
That said, the Bloomberg Barclays Sterling Gilts index made a 2.13 per cent total return in the final quarter of 2018 – which may ask some to question whether investors should be protecting portfolios with government bonds rather than absolute return funds.
Lowcock argued that absolute return funds can have a place in portfolios, so long as investors take the time to understand the approach taken by these strategies. As noted, the IA Targeted Absolute Return sector is a diverse one and its members can take vastly differing approaches to investing.
“Absolute return funds shouldn’t lose you much money in a bad 12 months, but likewise they aren’t supposed to make huge sums either: slow and steady is supposed to be the way,” he said.
“Bonds will offer some protection in a falling market but given the low yields still on offer they also present some risks – if interest rates do ever rise, especially more quickly than expected, investors could lose out.”
Performance of sector vs index in Q4 2018
Source: FE Analytics
Of course, the fact that the IA Targeted Absolute Return sector is such a mixed bag of funds means that performance outcomes can vary and nowhere was this more clear than in 2018.
Although the average fund in the peer group did make a loss, 17 of its 118 members ended the year in positive territory.
BlackRock Emerging Markets Absolute Alpha led the way with a 12.33 per cent total return, followed by Natixis H2O MultiReturns (10.36 per cent), TM Sanditon European Select (9.45 per cent), Man GLG UK Absolute Value (5.70 per cent) and Man GLG Alpha Select Alternative (5.46 per cent).
But large losses were witnessed in the sector as well, with City Financial Absolute Equity being down 17.58 per cent. VT iFunds Absolute Return Green, VT iFunds Absolute Return Orange, FP Argonaut Absolute Return and VT iFunds Absolute Return Indigo also lost more than 10 per cent.
The picture is also disappointing when it comes to some of the biggest funds in the peer group, which delivered a worse return than their average peer and lost more than the 3.79 per cent fall in the MSCI AC World index.
Invesco Global Targeted Returns is the largest member of the IA Targeted Absolute Return sector with assets under management of £11.6bn and it fell 3.85 per cent. The £11.3bn Standard Life Investments Global Absolute Return Strategies fund (often known as ‘GARS’) was down 6.08 per cent over 2018 while the £4.9bn Aviva Investors Multi Strategy Target Return fund lost 6.15 per cent.
All three funds take a similar approach, in that they bring together a diverse set of ideas or trading strategies that are designed to generate positive returns with lower volatility than global equities. These strategies have struggled in the recent past and all of the above have underperformed their average peer over the three years to the end of 2018.
Not every large IA Targeted Absolute Return fund underperformed, however. The £7.5bn Newton Real Return fund lost just 0.19 per cent over the course of 2018 while the £9.3bn Merian Global Equity Absolute Return fund was down 2.72 per cent.
Performance of funds vs sector over 3yrs
Source: FE Analytics
However, Informed Choice managing director Martin Bamford said the lacklustre performance from some of the biggest strategies in space should be a warning to investors.
“I’ve never been a fan of absolute funds. The sector as a whole has consistently failed to deliver on its stated aims once charges and inflation are taken into account. It’s been worrying to see the rising popularity of a handful of funds which follow strategies that are hard for the typical retail investor to understand and expensive once performed-related fees are taken into account,” he said.
“The vast majority of investors simply don’t need an absolute returns fund in their portfolio. They would be better off with a simple collection of low-cost funds, well-diversified across a range of different investment assets and sectors. The ability for fund managers to guess where the markets are going next is rightly called into question.
“Absolute return funds which aim to take hedge fund strategies and introduce them to retail investors were a mistake for the UK funds market.”