Fund briefing: Targeted absolute return funds
More than £5 billion has been ploughed into this sector over the past year, according to an analysis of data compiled by the Investment Association (IA), which represents the fund management industry.
As a result, it has been the best-selling sector in the past four quarters and eight of the past 12 months.
Justin Modray, founder of Candid Financial Advice, attributes the increased enthusiasm for the sector to volatile stock market conditions over the past year, but warns that they don’t provide a guaranteed route to riches.
“It’s not surprising investors have flocked to the perceived safety of the IA Targeted Return sector – but, given the patchy track record of funds in this sector, it remains to be seen whether this is a wise move,” he says.
A key problem is that although funds in this area all aim to make money in any market conditions, these returns are not actually guaranteed – and the success they’ve had in hitting this target has varied enormously.
“Picking funds in this sector is incredibly tough because none can be relied upon to consistently deliver what’s on the tin,” says Mr Modray. “Some funds are so cautious they struggle to deliver better than cash returns, while others are very aggressive and far more volatile than you would expect for this sector.”
Targeted absolute return funds embrace a variety of assets and investment strategies. The strategies used range from fairly straightforward long/short approaches, where managers
take ‘long positions’ in shares that are expected to appreciate and ‘short positions’ in those predicted to decline*, to more complex investment strategies.
* Moneywise says: A long position is the buying of a security such as a stock, commodity or currency with the expectation the asset will rise in value. A short position is a directional trading or investment strategy where the investor sells shares of borrowed stock in the open market.
The differences mean it’s virtually impossible to carry out a detailed like-for-like analysis of funds due to widespread confusion over their aims and approaches, especially as they all have different names, risk parameters, and investment time horizons.
It is a point acknowledged by the Investment Association (IA) – its sector guidelines insist funds state the timeframe over which they aim to meet their objectives, although this period must not be longer than three years.
In addition, the IA provides a monthly breakdown that shows how many times each fund has failed to deliver returns greater than zero after charges for rolling 12-month periods – and in some cases this makes for alarming reading.
The most recent statistics show the worst performers have failed to achieve this goal a staggering 22 times out of the past 24 periods. In fact, only three out of the 78 funds that can be analysed over the maximum timeframe have always hit this target.
Of course, not all of these funds are looking to achieve positive returns over one year, so prospective investors need to examine the targets, benchmarks and timescales for funds to see which best match their objectives.
They must also understand a particular fund’s goal, the assets in which it invests, and the charges that are applied. It is also important to establish whether they will have to pay performance fees for returns above a certain level.
Adrian Lowcock, investment director at Architas, suggests some funds in this sector can appeal to less adventurous investors, pointing out that capital preservation and diversification are among their strongest attributes. “They are very useful for investors looking to protect capital from volatile markets as they effectively offset some potential gain by taking a more cautious defensive approach,” he says. However, the mixed nature of the sector makes it diffi cult for investors to draw any meaningful conclusions.
This is illustrated by Morningstar data that reveals that the best performing portfolios over the year to 15 December 2016 returned an impressive 25%, while the worst were actually down by a similar amount.
There is a similar disparity over longer timeframes. Over the three years to 15 December 2016, the stand-out performers enjoyed double digit returns – the highest being 36% – while a significant number lost money over the same period.
However, Mr Lowcock advises against basing a decision on performance figures alone. Just because a portfolio has had a stellar period is no guarantee that it will be automatically repeated, so a degree of research is required.
“Some funds will have very specifi c strategies, which means they might win big one year, but not do so again for a while,” he explains. “Look for funds that have consistent performance and do particularly well when equity markets are falling.”
Mr Modray agrees. “All you can do is look for a manager who takes a common sense approach, has reasonable charges and appears to have weathered storms better than most in the past, but even this is no guarantee of future success,” he adds.
Fund to watch: Newton Real Return Fund
This fund aims to deliver a minimum return of what you would get from holding the money in cash plus an additional 4% over five years, before fees, from a portfolio of mainly UK and international securities.
For the cash benchmark, it uses the one-month sterling LIBOR rate, the interest rate at which a panel of selected banks borrow funds from one another in sterling with a maturity of one month. It also aims to achieve a positive return on a rolling three-year basis.
Iain Stewart, its experienced manager, adopts an absolute-return style, while also looking to preserve capital through security selection, diversifi cation and hedging strategies.
The fund, which takes a global multi-asset approach, has the flexibility to invest in conventional and alternative assets. Mr Stewart’s fund focuses on a stable core of predominantly traditional return-seeking assets with a capacity to generate capital and income, alongside an insulating layer of stabilising assets that are used to hedge risks and dampen volatility.
Return-seeking assets include 44% in equities – with the highest exposure to health care, consumer services and utilities – plus investments in corporate bonds, infrastructure funds and renewable energy.
The stabilising side accounts for 49% of assets under management, with around 28% in government bonds and 12% in precious metals, plus cash and index-linked positions.
Usually charged as a percentage of returns for performance above a specified benchmark, such as an index. The fee can range from 10% to 20% of total investment returns on a low starting benchmark such as Libor and investors could find themselves paying extra fees for merely average performance. Note that these funds do not compensate investors when the manager underperforms the benchmark.
The term is interchangeable with stock exchange, and is a market that deals in securities where market forces determine the price of securities traded. Stockmarket can refer to a specific exchange in a specific country (such as the London Stock Exchange) or the combined global stockmarkets as a single entity. The first stockmarket was established in Amsterdam in 1602 and the first British stock exchange was founded in 1698.
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).
A standard by which something is measured, usually the performance of investment funds against a specified index, such as the FTSE All-Share. Active fund managers look to outperform their benchmark index. Cautious fund managers aim to hold roughly the same proportion of each constituent as the benchmark, while a manager who deviates away from investing in the benchmark index’s constituents has a better chance of outperforming (or underperforming) the index.
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.