Report: IMA Absolute Return

The sector is defined to include those funds managed with the aim of delivering absolute (i.e. more than zero) returns in any market condition. At this stage it is also worth noting that inclusion is voluntary and that there is no asset based monitoring for this sector, meaning a broad variety of funds could be eligible for inclusion.

Nevertheless the relatively youthful nature of this asset class means 14 funds operate within the sector, and only five of these display a history of at least three years. This means that the sector cannot be scrutinised in great depth with the majority of funds yet to experience a full economic cycle – the essential factor to assess the true merits of such a vehicle.

Financial Express Analytics shows that the nine funds displaying a one year history have held up relatively well with the sector average preserving capital, returning -0.52% over the year. Although this is well above the FTSE 100’s loss of 15.72%, these funds are designed to produce absolute returns in all market conditions and should therefore renders any assessment against relative benchmark meaningless. On this notion, only six of these funds have succeeded in producing a positive return – Meaning investors must maintain a selective approach towards funds operating within this space.

However the risk element never fails to impress with an annual volatility outshining the FTSE 100’s 16.68%, given that the most risky fund was only 10.37%. It is also worth a mention that dogs do exist, which can be displayed by our worst performer, WAY’s Equity Portfolio, losing 5.29% with a volatility of 10.08%.

In terms of picking a winner, there are few that can challenge the infamous BlackRock UK Absolute Alpha fund, returning 8.13% given a volatility of 4.67% - a risk-reward combination that makes it of no surprise that the fund has attracted £842m of investors’ cash over the last six months.

Outlook

Absolute return funds have drawn mass attention over the year in-light of the flexibility such vehicles possess in tackling volatile market conditions. The surge of these vehicles have been further driven by UCITS III regulations, enabling managers increased investment powers to employ as part of their fund strategy. One notable feature, granted by these regulations, is the ability to short stocks and therefore take directional bets on stock prices falling, allowing such funds to prosper in times when market returns are diminishing.

Despite the current investment climate supporting these vehicles, our concern revolves around the abilities of such funds to keep up with long only alternatives if markets begin to recover – thus highlights the importance of market direction for these funds. Another notable drawback for absolute return vehicles is the FSA’s ban on shorting financial stocks, which can have a major impact on returns considering that many funds maintain outstanding short positions.

As we expect markets to continue their down trend, absolute return funds stay attractive. Investors should nevertheless remain selective and seek out those fund managers displaying a superior ability to take directional bets on stocks. As the IMA only have an inclusion of 14 funds, investors may also want to draw their attention to Financial Express’ Absolute Return sector which maintains a broader inclusion of 47 funds for investors to pick from.

*Source of data: Financial Express Analytics