Within the UK All-Companies sector the best performing fund over the year to the end of November 2008 has been the Skandia UK Strategic Best Ideas fund which has returned -14.56 per cent. This doesn’t sound too impressive until viewed against the market performance for the same period. The FTSE All Share lost 32.24 per cent. Other top performers in UK equities are BlackRock’s UK Absolute Alpha fund that returned 1.67 per cent over the same one year period and Cazenove’s UK Absolute Target fund, which has managed to produce returns of 4.61 per cent since its launch in July.
All three funds follow more sophisticated strategies than is traditionally the case with UK equities funds. Key to these funds investment approach is their use of derivatives and robust risk management processes. The funds ability to short sell and their comprehensive approach to risk management have allowed them to avoid, and even profit from, the difficult economic and market conditions that have been damaging so many UK equity funds this year.
BlackRock’s Head of UK Retail, Alex Hoctor-Duncan, cites their meticulous approach to risk management as giving them an advantage when coping with the market shocks of the last twelve months.
“Risk management has always been a big part of our philosophy at BlackRock, but I guess it’s only now that the benefits are becoming more apparent.
“Risk management has become an integrated part of the management process. We try to identify all possible forms and sources of risk in our investments, from liquidity risk to thematic risk, and perform comprehensive ‘what if’ scenario analysis to identify what effect these might have on the portfolio. The fund manager can then factor this information into their stock selection decisions.”
In contrast the worst performing funds in the IMA UK All Companies sector over the same one year period are the Rathbone Special Situations fund and the SVM UK Opportunities fund which have lost 58.13 per cent and 58.56 per cent respectively.
Traditional long only equity products tend to out perform absolute return products in rising markets but take substantial losses in falling ones. While in the long run these products are likely to produce a positive return, investors are being increasingly influenced by the short term effects on their portfolios. Investor’s willingness to suffer downside volatility is decreasing; managing these risks will become ever more important for managers as they try to attract new business.
Strong track records will no longer be enough if the events of the past eighteen months continue to influence attitudes towards risk in the future. Increasingly, the processes that are in place to minimise losses will become as important as what the manager can do to make money. This increased emphasis on absolute returns can be seen by the high weighting to the BlackRock UK Absolute Alpha fund and Cazenove UK Absolute Target fund in the AFI. Both funds are in the top ten for all three indices.
While the advantages of absolute return funds seem clear, investors are still turning to the more traditional methods of preserving capital. As Brian Dennehy, managing director of leading IFA firm Dennehy Weller & co and AFI panelist observes.
“We’ve seen no increase in demand from clients for absolute return funds. In so far as there is unprompted demand for anything it is for income funds and corporate bonds in particular.”
In the long run then, Absolute Return products are likely to be of increased importance to investors as they look to minimise the downside risk and volatility when pursuing growth. In times of extreme stress in the markets however, it seems that investors are sticking with the investments they’re familiar with.