As an investor, if you buy an absolute return fund, you typically buy it with the expectation of getting a positive return across a certain time frame.
However, there are a number of reasons why these funds may slip into negative territory and, as such, some fail to achieve this.
Below, FE Trustnet asks investment professionals how much they thought was too much to lose when investing in an absolute return fund.
Wellian Investment Solutions chief investment officer Richard Philbin said that it is not an easy question to answer given the diverse nature of absolute return funds.
Indeed, there are 122 funds in the IA Targeted Absolute Return sector, which have varied returns and volatility measures.
For example, the best-performing fund in the sector (City Financial Absolute Equity) over five years is up almost 45 per cent, but it is also the most volatile at nearly 15 per cent.
The worst performing fund, Threadneedle Absolute Return Bond, on the other hand, has lost nearly 10 per cent while the least volatile fund over the period, Kames Absolute Return Bond, has a volatility figure of 0.67 per cent.
Best- and worst-performing absolute return fund over 5yrs
Source: FE Analytics
Philbin said that when you add the fact that these funds are investing in different assets, it is not a sector that should be viewed or measured holistically. Part of the issue, he added, is that absolute funds have different time frames.
“Doing a deeper dive into the objectives of the funds themselves also provides an insight into the way the manager defines 'absolute return' – some managers will look at delivering a positive return annually, others over rolling three-year cycles, and others over an economic cycle,” the CIO noted.
“The time frame considered will help define the investment class you will choose which in turn will probably define the downside losses.”
Therefore, before the question of how much is too much to lose in an absolute return fund, you should ask yourself how long a time frame you have, he said.
“The longer the time frame, the greater probability of greater shorter-term losses, but correspondingly, the greater the upside potential.”
Philbin said that if you want an absolute return fund for a short-term capital need or an insurance policy to protect your portfolio, then he would recommend a cash/bond type investment where an acceptable level of loss would be a maximum of 2 per cent.
AJ Bell’s head of active portfolios Ryan Hughes noted that, as well as time frame, the type of strategy employed by the fund’s manager will also determine how much is an acceptable amount to lose in an absolute return fund.
“Some equity market neutral strategies or absolute return fixed interest strategies take very little risk and therefore you would expect losses to be minimal while other global macro or long/short equity strategies may be taking a lot of risk which will magnify both upside and downside returns,” he said.
Hughes noted when looking at a ‘proper’ absolute return fund that looks to control risk, he would expect his downside to be no more than 10 per cent over a 12-month period.
“I do also have a very simple rule I use; that is, if an absolute return fund can go up by 50 per cent in a year like some have, there is a good chance that it can go down substantially too,” he said.
“Where funds have this type of performance profile, I tend to reclassify them as equity funds rather than absolute return as the risk/return profile is much more akin to equity and should be considered as such.”
Although he said it is impossible to recommend any type of fund that doesn’t have the possibility of losing money, Hughes noted Janus Henderson UK Absolute Return is one fund that he does like.
Performance of fund vs sector over 5yrs
Source: FE Analytics
“Fund managers Ben Wallace and Luke Newman are a very experienced pair and have managed the fund since launch in 2009 and therefore have excellent experience of managing risk,” he said.
“The fund is split between core holdings and tactical holdings, of which long and short ideas can comprise either category.
“Over the last nine years, it has a maximum drawdown of just under 5 per cent and an annualised return of over 5 per cent demonstrating just how well they have managed to manage risk and still generate returns.”
Managing director of Whitchurch Securities Gavin Haynes meanwhile recommends the Jupiter Absolute Return fund.
“Despite having a difficult time recently, if conditions for stock markets get more difficult it can provide useful diversification to a portfolio,” he said.
It is managed primarily as a long/short UK and overseas equities fund but also has the flexibility to invest in other asset classes.
“Fund manager James Clunie has particularly shown a demonstrable success on his short-selling and with stock markets at elevated levels this is a good option then to provide some protection for trickier times.”
Hargreaves Lansdown research director Mark Dampier cautioned however that these types of strategies (that look to limit how much of the downside they capture) do not tend to make for good investments in a bull market.
“The argument in favour of the absolute fund would be if you fall 50 per cent, you’ve got to make 100 per cent,” he said.
“That’s the sort of argument, although Sebastian Lyon at Trojan doesn’t run an absolute fund, his argument is, if you don’t lose too much it’s easier to make up.
“And he is right in that way but I’d also say if you don’t capture a lot of the bull market what are you doing for clients?”
Dampier said that this is what makes an absolute return fund difficult to market. Indeed, he said that while advisers like the asset class it can prove a hard sell to their clients.
For example, he said if someone were go to an adviser with a negative view on the market they may well be suggested an absolute return fund.
While an absolute return fund may lose 5 per cent at a time when the market falls a lot more, the client could argue they would have been better off in cash.
On the other hand, Dampier said that the adviser would view the above scenario in a more positive light as they would have beaten the market.
As a result of this, in Hargreaves Lansdown’s Wealth 150 list – a selection of Hargreaves’ Lansdown’s 150 favourite funds – Dampier said there are very few absolute return funds as getting the balance of the strategy right (to outperform in both up and down markets) is extremely difficult.
Performance of fund vs sector over 3yrs
Source: FE Analytics
“Just look at the fate of GARS [Standard Life Investments Global Absolute Return Strategies] over the last three or four years to show that you don’t want all your money in any one type of fund anyway because they all perform differently in themselves,” he said.
GARS is one of the biggest funds in the Investment Association and has over £17.5bn in assets under management. In the long-term, the fund has been a strong performer, however recently the fund has struggled and over one and three years the fund is down 2.80 and 5.24 per cent respectively.
It was the most sold fund in the Investment Association in 2017, losing nearly £5bn of its value and has already lost £2bn in the first half of this year.
As such, he said if he were to recommend investing in the sector, he would use a combination of strategies.