Absolute return funds, which aim to deliver a positive return no matter what way the market is going, have been very popular with investors, thanks in many ways to uncertainty in light of the 2008 financial crisis.
However Spear says he has not been using these products recently as he believes the global economy is strengthening, which will further buoy equity markets.
“Targeted absolute return funds have a place in a diversified portfolio but if equities are going to have a good run, which they will do over the next five years, their effect is going to be muted,” he said.
“I’ve not sold-out of them completely but I don’t think they will have anything other than a benign effect in a portfolio over the next five years, so I am recommending reducing exposure to them.”
“As the funds aim to neutralise the market by capturing the upside whilst dampening the downside, you are going to have good years but you are also going to have very benign years and I think these funds are going to be fairly benign over the medium-term.”
“In a strongly rising market they are going to disappoint, so I can only see them as a diversification [tool in] a bigger portfolio.”
Spear recommends investors use dividends that provide a regular income stream as a way of not only maximising returns, but also dampening risk. Companies with a strong dividend culture tend to perform better in falling markets, and the income itself serves as a buffer during tough times.
He recommends the Fidelity Multi-Asset Income fund for lower risk investors, Invesco Perpetual Distribution and Artemis Managed Distribution for balanced investors, and the Threadneedle Monthly Income fund for those prepared to take on a higher level of risk.
“We are likely to see emerging markets, commodities and property come back and absolute return is likely to get washed out by this,” he added.
Spear’s bullish outlook is partly shared by James McDaid, investment manager at GAM; however he recommends greater caution and says he is holding on to absolute return funds despite the fact he thinks markets will continue to rise.
“Return is only one aspect of an investment. One must also consider the risk characteristics of investments within a broader portfolio,” he said.
“Since inception, we have held absolute return funds within our strategies as both a volatility dampener and a source of lower risk return in light of stretched fixed interest valuations.”
“Even with stock markets and economic news pointing towards further gains for equity holders, we continue to believe that absolute return funds are an important element of a broad portfolio.”
One of the most consistent absolute return funds in terms of performance has been the £93m City Financial UK Equity fund managed by David Crawford.
It is the best performer in the sector over one, three and five years. Over three years it has returned 76.54 per cent compared to a sector average of just 8.21 per cent.
In spite of its strong performance, the fund has a very high risk profile, operating with a similar level of the FTSE All Share in recent years.
For a more defensive core option, McDaid recommends the €943m Alken Absolute Return Europe fund managed by Nicholas Walewski.
The fund has returned 18.05 per cent over three years compared to an FO Absolute Return sector average of 1.13 per cent. This period includes a period of both strongly rising and falling markets.
Performance of fund and sector over 3yrs
Source: FE Analytics
“Nicholas is an experienced and successful manager in the European long/short equity space, and we have confidence in his ability to generate long-term absolute returns under both exuberant and challenging stock markets,” McDaid said.
One of the most popular funds in the IMA Targeted Absolute Return sector, as well as the whole IMA universe, is the Standard Life Investments Global Absolute Return Strategy (GARS) fund.
The fund, which has a staggering £20bn in assets under management, has had a relatively strong period of performance over three years, returning 15.92 per cent compared to a sector average of 8.21 per cent.
Performance of fund and sector over 3yrs
Source: FE Analytics
Spear is generally wary of absolute return at the moment given his bullish stance, but has particular reservations over GARS. He says it’s a fund to hold, but not one worth adding to or buying.
“When bond funds start to look illiquid and that they might lose you money, an absolute return fund normally has the opportunity to make you money and give you a little upside.”
“However, Standard Life Investments GARS is a really huge fund and looking almost like a quasi-bond fund at the moment and as much as they say they can cope with the size, I am reticent they can.”