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
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%.
Lower interest rates encourage people to spend, not save. But when interest rates can go no lower and there is a sharp drop in consumer and business spending, a central bank’s only option to stimulate demand is to pump money into the economy directly. This is quantitative easing. The Bank of England purchases assets (usually government bonds, or gilts) from private sector businesses such as insurance companies, banks and pension funds financed by new money the Bank creates electronically (it doesn’t physically print the banknotes). The sellers use the money to switch into other assets, such as shares or corporate bonds or else use it to lend to consumers and businesses, which pushes up demand and stimulates the economy.
Generic, loosely-defined term for markets in a newly industrialised or Third World country that is in the process of moving from a closed economy to an open market economy while building accountability within the system. The World Bank recognises 28 countries as emerging markets, including Argentina, Brazil, China, Czech Republic, Egypt, India, Israel, Morocco, Russia and Venezuela. Because these countries carry additional political, economic and currency risks, investors in emerging markets should accept volatile returns. There is potential to make large profit at the risk of large losses.
A term applied to raw materials (gold, oil) and foodstuffs (wheat, pork bellies) traded on exchanges throughout the world. Since no one really wants to transport all those heavy materials, what is actually traded are commodities futures contracts or options. These are agreements to buy or sell at an agreed price on a specific date. Because commodity prices are volatile, investing in futures is certainly not for the casual investor.
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.
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).