The rise of a sector that promises returns in any market
The absolute return sector was only formed in April 2008, but its success has helped it pull in a lot of new money and an increasing number of managers.
Funds in this sector seek to make money regardless of market conditions and put a high priority on capital preservation. The sector held up far better than the FTSE All Share over the last year, and with the economic outlook still highly uncertain, it retains its appeal. Yet there are some caveats.
Firstly, some absolute return funds – those with words such as ‘bond’ in their titles – have much narrower remits than others. This can make it harder for them to dodge difficulties than those able to invest in almost any asset class.
Second, their emphasis on capital preservation means they underperform in strongly rising markets – although their resilience in hard times means they can claim creditable long-term figures.
And lastly, the techniques employed by some absolute return funds, such as taking out ‘put options’ (going short on shares) which they expect to fall, can be risky and expensive. Nick Osborne, co-manager of BlackRock UK Absolute Alpha fund, says: “Shorts are riskier than longs – longs can only ever go to zero, while a short can rise infinitely.”
Launched in April 2005, BlackRock UK Absolute Alpha has become the largest fund in the sector, despite introducing a steep performance fee, which takes 20% of any gains in excess of the annualised returns on 12 month LIBOR (the London Interbank Offered Rate).
The BlackRock fund is similar to a long/short hedge fund in that it goes short as well as long on individual shares, invests in a variety of asset classes, and is willing to go at least 60% liquid.
The fund tops the sector over three years. But its much increased size, as well as its high fees and heavy concentration on the UK market, could slow future progress.
Osborne says: “Share prices are moving incredibly fast and market volatility is likely to continue, so we’re grateful for the extra flexibility that a fund of this nature gives us. Absolute return products can be nirvana for investors, delivering positive returns irrespective of market direction – however, it’s even more crucial to look under the bonnet to ensure that the managers have the skills and resources to deliver what they promise.”
Newton Real Return fund, which has performed almost as well over the last three years, has no performance fee, is less than half as big, and invests internationally. Formerly called Newton Absolute Intrepid, it does not go short on individual shares, though it does use derivatives to protect the fund against major market movements.
Unfortunately, it was in the middle of rearranging its protective mechanisms when the market nosedived last October, and it suffered a steep setback. But it bounced back rapidly due to its holdings in gold, US fixed interest and some exceptionally defensive equity holdings. As a result, remarkably, it ended 2008 with a net gain.
The fund adopted its absolute return remit in 2004, and Iain Stewart (Newton’s lead manager for multi-asset and global equity market mandates) has managed it ever since.
As Stewart is worried about the financial outlook, the portfolio is relatively defensively positioned, with 56% in equities – with the emphasis on high-yield shares in large, stable businesses – and 15% each in bonds and cash. The balance of the portfolio is mostly in inflationary hedges, such as gold and agricultural exchange-traded funds, plus gold-related equities.
Newton Real Return aims to exceed LIBOR plus 4% per year – and has done much better than that over its five-year life, as well as substantially outperforming the All Share and the MSCI World index.
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
The London Inter-Bank Offer Rate is the rate at which banks lend to each other over the short term from overnight to five years. The LIBOR market enables banks to cover temporary shortages of capital by borrowing from banks with surpluses and vice versa and reduces the need for each bank to hold large quantities of liquid assets (cash), enabling it to release funds for more profitable lending. LIBOR rates are used to determine interest rates on many types of loan and credit products such as credit cards, adjustable rate mortgages and business loans.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
Absolute return funds
Absolute return funds aim to deliver a positive (or ‘absolute’) return every year regardless of what happens in the stockmarket. Unlike traditional funds, they can take bets on shares falling, as well as rising. This is not to say they can’t fall in value; they do. However, over the years, they should have less volatile performance than traditional funds.
This is more usually a feature of car insurance but it can also crop up in contents, mobile phone and pet insurance policies. An excess is the amount of money you have to pay before the insurance company starts paying out. The excess makes up the first part of a claim, so if your excess is £100 and your claim is for £500, you would pay the first £100 and the insurer the remaining £400. Many online insures let you set your own excess, but the lower the excess, the more expensive the premium will be.