Risks and considerations
While the appeal of Absolute Return funds is obvious, their ability to consistently produce positive returns with low levels of volatility has been heavily scrutinised since the sector launched in April 2008.
From afar, the sector seems to have achieved what it set out to do. According to FE Analytics data, IMA Absolute Return has returned 10.13 per cent in the last three years, marginally outperforming the consumer price index (CPI), and only the Money Market sector has been less volatile. The far more volatile FTSE All Share returned only 9.11 per cent more than the sector during this time.
Performance of sector vs inflation
Source: FE Analytics
When looking more closely at individual funds, however, cracks start to appear. Two funds – Elite LJ Absolute Return Portfolio and Insight Diversified Target Return – have lost money in the last three years, and in the past 12 months, 12 funds have failed to break even.
Although the funds attempt to deliver positive returns no matter the market condition, half of the vehicles in the sector lost money in 2008. With a growing number of experts predicting another bear market, many investors are turning to Absolute Return funds to protect their capital. Whether they can actually do this is another story.
The level of volatility seen in some funds is also a cause for concern. David Crawford’s Octopus Absolute UK Equity is the third-best performing fund in its sector over three years, but it is the worst-performing fund over the past 12 months, losing investors 8.83 per cent of their cash.
Certain funds in the sector are willing to take on greater risk than others. Lothar Mentel, chief investment officer at Octopus, believes that the ultimate problem lies in the IMA's definition of Absolute Return. He says the body is pitting funds with contrasting objectives and styles against each other, which is misleading investors.
In January this year, the IMA said it is considering splitting the sector, but has not yet indicated what the likely outcome will be.
Key funds
The sector does contain some genuine success stories. According to FE Analytics, the size of Iain Stewart’s Newton Real Return fund increased from £922m in assets under management (AUM) in January 2010 to more than £4bn by the end of July 2011.
The fund, which was launched before the Absolute Return sector came into being, has returned 54.01 per cent to investors over five years, outperforming its sector average by more than 30 per cent.
Performance of fund vs sector
Source: FE Analytics
Schroder ISF Emerging Markets Debt Absolute Return is also worth a mention. The fund is the second-best performing fund in the sector over three and five years, with returns of 51.58 and 37.01 per cent respectively. However, the fund is more volatile than Stewart’s vehicle, and has a higher FE Risk Score.
Our view
The sector is an excellent option for investors looking to protect themselves from downside risk, but choosing the right product is absolutely crucial. A lot of investment houses are handling Absolute Return for the first time, and some vehicles have suffered from poor, inexperienced management.
Given the current market uncertainty, a solid Absolute Return fund with a proven track record is a worthwhile investment.