Incorrect long and short positions across countries and styles as well as poor stock picking has seen Jupiter Absolute Return suffer over the last year, according to manager James Clunie.
But market commentators said investors should continue to back his approach, which could be coming into its own if market volatility continues to pick up.
The three FE Crown-rated fund had a difficult 2017, losing 2.57 per cent over the course of the year, and has struggled so far in 2018, down a further 1.12 per cent year-to-date. So, what’s behind its recent performance?
Performance of fund vs benchmark and MSCI AC World since start of 2016
Source: FE Analytics
The £1.4bn Jupiter Absolute Return fund is a long/short strategy that despite having more long positions (around 75) than short positions (around 135) is roughly equity market neutral.
“However, the shorts that we have are much riskier than the longs that we have in the sense that they have higher beta,” Clunie said.
This is because many of the firms he is shorting are highly levered by sometimes as much as five or 10 to one and are therefore very reactive to the market.
He also shorts glamourous stocks such as Tesla and Nvidia, which are very volatile stocks that can move a lot in a day.
The manager said: “The net result is the fund has had a negative beta for the last three years and at the moment (for the last year) we have had a beta of around -15 per cent.
“In other words, it slightly leans against the market. So if the market goes up the fund should go down a bit and if the market goes down the fund should go up a bit.”
However, Clunie noted that some clients and investors have the misconception that because the fund uses a short book, that when the market falls it should rise by the same amount.
Indeed, during the latest market correction, the fund returned 27 basis points while the market was down 6.45 per cent, but many saw this as underperformance.
“I think some clients thought when the market was down 6 per cent, because we do a lot of shorting we should be up 6 per cent,” Clunie said.
“Last year world markets were up about 20 per cent. Was our fund down 20 per cent? No, it was down 3 per cent and that is roughly 15 per cent of that 20. It actually went down last year as much as you would expect it to with that kind of beta.”
“The fund didn’t go down one-for-one for the market so isn’t going to go up one-for-one with the market. It is going to up about 15 per cent of what the market goes down plus or minus what the stocks do and really what we are offering is what the stocks do – are we good stock pickers?”
However, the manager admitted that he did a “bad job at picking short positions” last year – something that he found difficult to understand.
“We are normally able to demonstrate that we pick good shorts but last year was bad and we deleted 3 per cent of value from our short stock picking,” he said.
Much of this was due to the large number of US short positions as the country ended up being one of the better markets last year.
Indeed, as the below chart shows, the S&P 500 was the second-best performing of all the major indices last year, returning 21.1 per cent in local currency terms.
Performance of indices in 2017
Source: FE Analytics
“Performance was partly to do with country – short US, long UK, Japan and Russia – partly do with style – long value, short growth – and partly because we just picked bad shorts,” Clunie said.
Meanwhile, the latest correction wasn’t as helpful for Jupiter Absolute Return as it could have been, with markets selling off more broadly rather than being the start of a sector rotation.
“It wasn’t that helpful for us other than that markets fell a bit and volatility picked up a bit,” the manager said.
“I was a bit disappointed but I think we are going to do well when there is a proper regime change, whether we go from bull into bear or there is a move from growth to value or investors become more risk aware.”
As yet there is no evidence that this rotation is imminent, although some investors have argued that the end of the 36-year bull market in bonds will be so gentle a turn that they barely need to react to it. However, Clunie said this would be a “catastrophic mistake” and that “the time for different thinkers will come”.
He noted that at the time of rotation can be the most painful period for his strategy as it might take six months or a year for the markets to fully price it in, but that at some point this reversal should happen. After this period, however, he would expect the strategy to outperform.
Jason Hollands, managing director at Tilney Group, agreed, noting that absolute return funds could be used as the defensive holding in a portfolio that bonds once were.
“We hold absolute return funds in most client portfolios and in an environment where investors would historically hold bonds as their defensive ballast to offset the volatility of equities, when bond markets have been even more mispriced than equity markets and could face a lot of volatility as rates rise, arguably absolute return funds should step into the fray and perhaps be used an as an alternative for a low volatility part of a portfolio,” he said.
As such, he added that the Jupiter Absolute Return fund may be a good option to hold on to as a defensive anchor.
“I would hold it. James Clunie is a good manager who has had a lot of success over the long run and there is nothing that would lead us to think something fundamental has changed in the process,” Hollands said.
Since Clunie took over the fund it has made 14.07 per cent with volatility of 5.18 per cent, as the below chart shows.
Performance of fund vs benchmark and MSCI AC World since manager start
Source: FE Analytics
Mike Paul, fund analyst at Brewin Dolphin, said he would buy the fund, despite its recent poor performance and recent troubles with the short book.
“We believe the manager has a potential ‘edge’ in single stock short selling, which is not well suited to an environment where equity markets are rising strongly with very little volatility,” he said.
“Further his positioning, directionally (the fund has a negative beta), thematically (long ‘value’, short ‘not value’) and geographically (long UK, short US) have all been ‘wrong’ given the recent trends in the market.
“In this context, for the fund to be down only 2.5 per cent in 2017 could be considered a good outcome.”
More structurally, Paul said the fund forms part of his absolute return allocation, in which he is looking for assets that perform differently to the equity and debt positions in the portfolio.
“Given the current characteristics of the fund, with negative equity beta, negative duration and long volatility, we are comfortable that it continues to serve this purpose as a diversifier within portfolios,” he said.
Jupiter Absolute Return has a clean ongoing charges figure (OCF) of 0.84 per cent.