Global equity plays have been the biggest negative contributors to Standard Life Global Absolute Return Strategies fund’s underperformance over the last quarter, according to Adam Rudd. 
The multi-asset investment director at Standard Life says that the choppy performance of equities during the first three months of 2016 – with markets plummeting in the former six weeks and rebounding in the latter – meant many pair trades that reside in the behemoth fund’s £26.2bn portfolio behaved differently than expected.
The three crown-rated fund (which is often referred to as GARS) is the best-known vehicle within the absolute return space and is popular with investors, having significantly outperformed its LIBOR 6 Month GBP benchmark over three and five years while maintaining less than half of the annualised volatility of the MSCI AC World index.
Performance of fund vs benchmark and MSCI AC World over 5yrs
Source: FE Analytics
However, some investors have been somewhat deterred by its underperformance over the last year as it has lost 4.28 per cent compared to the index’s loss of 1.92 per cent and its benchmark’s return of 0.74 per cent.
It is important to note, though, that the management team aims to provide positive investment returns in excess of cash over rolling three-year periods.
Over the last quarter GARS has provided a total loss of 3.29 per cent, underperforming the MSCI AC World and its benchmark by 6.08 and 3.47 percentage points respectively.
Rudd says that there have been clear themes regarding the positions that have delivered the most positive and most negative performances.
“We have duration exposure in some form or another in all of our top five contributors. US relative interest rates – this is a position where we are long five year, five year interest rates, short one year, one year and short 15 year, 25 year rates – it’s what we call a butterfly trade,” he explained.
“What we’ve seen with rates coming lower at the five year point of the curve is that it has rallied more than either the front or back of the curve.”
“We added a new strategy where we hold short 20 year, 10 year interest rate swaps and we’ve added a long position in US treasury inflation-protected securities, so a portfolio of tips [US equivalent of index-linked gilts] with a maturity of between six and 10 years, that’s been a positive contributor.”
Other positive contributors to the fund’s portfolio over the last quarter have been its long duration exposure in Australia through holding 10-year government bond futures and its high-yield holdings in the region.
While fixed income plays proved to be the most lucrative for GARS year-to-date, the fund was bruised by the team’s pairing of a long US dollar position versus a short Singapore dollar position, a negative return from a long US banks versus short US consumer staples position, and a short US duration position.
In terms of equities, the fund’s performance was knocked by its exposure to European stocks, an area of the market that many investors have been nervous on recently given the market’s heavy exposure to banks.
“Although global equities fell during the first part of the quarter and then subsequently rebounded – European equities, due to the strength in the euro, have fared less well than the rest of equities did in the subsequent rebound so that still contributed negatively to the GARS portfolio,” Rudd explained.
Performance of indices in 2016
Source: FE Analytics
“There was a material drawdown during the first six weeks of the year. The S&P was down 10.5 per cent, the Euro Stoxx 50 was down 18 per cent and the Nikkei 225 was down 21 per cent.”
“Subsequent to that equities rebounded. All of these different indices rebounded by about 10 per cent so that left the Euro Stoxx down by 8 per cent and the Nikkei down 12 per cent – so the places where we’ve had our equity exposure has been negative for the quarter.”
As we head through Q2 though, the management team at GARS has repositioned the portfolio in a way that they hope will be boosted by current macroeconomic trends.
One of the changes that the team recently made was to close their European banks versus European insurers position. This position was initially held because of the GARS team’s belief that low interest rates in Europe would significantly impact the insurers in the region, as it thought returns on the assets would undershoot discount rates associated with liabilities in the future.
“It’s unlikely that the regulator would want to come out and force insurers to recognise that immediately, but we felt if it didn’t happen that way, it would likely happen through a lack of competitiveness on variable annuity products and competing with other products given the guaranteed low return potential,” Rudd continued.
“We felt that the low interest rate environment was a difficulty for insurers but in an environment where you have relatively few sources of dividend payers and growers – energy companies, banks and miners have all been cutting their dividends – we felt European insurers were being used as a safer higher-quality investment area.”
“So, while we still think low interest rates are a negative driver for insurers, we didn’t think it was a sufficient reason to hold that strategy any longer.”
On the other side of the pairing, Rudd points out that European banks have been exposed to risks surrounding capital-raising, which could pose a problem for firms with weaker balance sheets. He therefore says it was a benefit not to hold this position throughout the course of the quarter and that this theme may well continue going forwards.
Another move the GARS team made is increasing its weighting in its US dollar versus the Singapore dollar and the Korean won position.
“In the month of January there were fears about the renminbi devaluation and we hold Singapore dollar and Korean won short positions, which we feel are like having proxies for short Chinese currency exposure,” Rudd said.
“The Chinese currency is carefully controlled, so while we think Chinese growth is slowing and it's likely the currency will be in a steady devaluation, we think there’s a potential for making a return on these currency pairs even if the Chinese Yuan is relatively well controlled.”
The team has also added a new strategy to the portfolio over the last few months – long US real interest rates versus nominal steepener, which aims to reap the benefits of a return of an inflation premium within the US interest rate curve.
This, according to Rudd, is designed to benefit from an initial drop in real interest rates at the front of the curve and an increase in nominal rates over the longer term.
“This combination has been useful in the portfolio – inflation expectations fell as credit spreads widened. Since then part of the solution has been a lower indicated hiking cycle from the Fed.”
“As equities rallied and credit spreads tightened inflation expectation rebounded to some extent, but at the same time real yields have fallen so in a sense, we’ve been proven correct on both sides in terms of inflation expectations moving higher and the real yield component becoming lower.”
Standard Life GARS has a clean ongoing charges figure of 0.89 per cent.