Industry Insider: why absolute returns are my choice for 2016

I hope by the time you read this, it has raised rates – otherwise, you have to wonder if it ever will.

If the Fed takes the plunge, we could see an interesting start to 2016 in terms of markets.

No one expects four 0.25% increases in short succession – which would typically mark the start of a cycle of interest rate rises – but markets don’t like the unknown and that is what we are facing as quantitative tightening (or QT as it will surely become known) begins.

The markets will need to understand the trajectory of rate rises from here and if the Fed makes a mess of the forward guidance (its track record of late has not been good), we can expect some continued volatility.

Geopolitical risk has been adding to volatility and, at any other time, I would be less concerned as markets usually resume their course after things quieten down. But we are currently experiencing quite the opposite.

The list of combatants in the global battle for ideological, political and economic superiority grows daily. Game theorists believe there should be an optimal outcome and we have to hope that they are right.

So as January settles in, I’m erring on the side of caution. When it comes to equities, nothing is cheap any more, bar one or two emerging markets – which may get cheaper – so I favour Europe and Japan. Both economies are still in the quantitative easing (QE) phase and, if we’ve learnt anything in the past few years, it’s that QE is positive for stocks.

I suspect the only way to make any kind of return from bonds is to look for a decent yield to cushion you from any price falls.That means corporate bonds, both investment grade and high yield. Stock selection will be key, however, as most economies are in the stage of the cycle where companies are acting to please shareholders, not creditors.

I’m neutral on commercial property: returns may be more moderate than the past couple of years, with mid-single digits.

And I think it is a bit too early for commodities. Global growth has to pick up first and QT may well put the breaks on what is already a slow-moving vehicle.

So my area of choice for any new investments this year is targeted absolute return funds. They act as a good diversifier in a wider portfolio and the good ones do what they set out to do. A word of caution: the sector holds a large number of funds that do very different things, so it is important you look closely at each before investing, to make sure you are comfortable with what they are trying to achieve and how they will go about it.

When it comes to long/short equity styles in this sector, my favourites are Henderson UK Absolute Return and Smith & Williamson Enterprise. If you want lower-risk, multi-asset funds, then Church House Tenax Absolute Return Strategies and Premier Defensive Growth are worth a look.

Darius McDermott is the managing director of FundCalibre