Last year was a difficult year for most types of investor, with volatility shooting up and trends breaking down.
One group of investors arguably should have outperformed in this hazardous environment – absolute returns managers.
This broad church of investors includes everything from high-octane long-short hedgies all the way to volatility managers more focused on a defensive strategy.
We can narrow the universe down using the Investment Association’s own definition of targeted absolute returns funds – the trade association defines this gaggle of over 100 funds thus: 'The Targeted Absolute Return sector contains funds that aim to deliver positive returns in any market conditions, but returns are not guaranteed'.
There are other bells and whistles to add to the definition, especially around the time frame of the stated fund objective, but I would suggest that a common-sense application of what defines this sector is also sensible. Many investors choose to use these funds because:
- They are outcome based, not built using some arbitrary market or region-based benchmark.
- They suggest positive returns through the cycle of markets, with many offering a combination of both long (bullish) and short (bearish) positions.
- They might in a narrow sense act as an alternative to cash, in that many managers suggest a target of Libor plus a percentage point or so.
- Lastly, they also offer the potential for dampened down volatility: you shouldn’t suffer big losses or big gains because of the strategies which err towards market neutral positions. Call me old fashioned, but in my humble opinion this tends to imply a consistency in returns over a number of years.
Add that all up and I think the promise of absolute returns funds is mightily alluring – what’s not to like about this (Herculean) solution? The slight fly in the ointment is the results, as it always is!
How the results stack up
I would suggest that 2018 was the perfect year to test out the varied and many promises of targeted absolute returns funds.
Unfortunately, as a sector it was found wanting. I spent a rather boring afternoon looking through absolute return funds’ 2018 returns – all 107 funds by my measure.
The good news is that there were some stellar performers with familiar names in the top 10 in terms of total returns.
BlackRock’s Emerging Markets Absolute Alpha fund had a cracking 2018 with a 12% return but not far behind came H2O MultiReturns, various Sanditon funds (European and UK Select) BlackRock European Absolute Alpha, Odey Absolute Return and the GAM Star funds.
If we slip into the broader 20 we’ll find other familiar names such as Premier Defensive Growth, Newton Real Return plus new names (in retail at least) such as Winton with its Absolute Return Futures fund.
Now for the bad news. Of the 102 funds reporting full-year 2018 returns, only 12 reported an absolute positive return – the other 90 reported negative returns. Even worse, five reported losses of 10% or more while 30 funds reported losses of 5% or more.
Let’s return to my original summary of the virtues of absolute returns investing. In terms of simple outcomes, most funds failed to produce a positive return last year. Clearly all those hedging, short and volatility rewarded strategies failed to produce sufficient returns to compensate for losses.
I’ll skip over the task of producing Libor-plus returns and focus on consistency and volatility. I’m fairly shocked that a long tail of targeted absolute returns funds actually lost more than 5% in the last year, with 5 losing more than 10%.
My guess is that investors in these straggler funds are now fairly unhappy at the results. To put it as plainly as I can, most investors choose to invest in this type of fund to precisely avoid this scale of losses.
Consistent, these funds ain't
As for the consistency, let’s look at the top performers. I rate Sanditon very highly as a fund house. Its European Select fund gained 9.4% in 2018 but in 2017 it lost 6.5%, 0.8% in 2016 and 4.8% in 2015. Likewise, with the eponymous Odey Absolute Returns fund – arguably one of the best managers in the long short space. It returned 3.8% in 2018 but lost -17.8% in 2016. To be fair to the Odey fund, in most other years it has produced positive results.
Another way of looking at these numbers is to ask how many of the top 10 managers in 2018 have produced consistently positive returns over the last five discrete years. The answer: one, H2O MultiReturns.
If we extend this search out to the top 20 in 2018, we are still left with the H2O fund plus three others which notched up tiny negative returns. I get similar results if I look at the top performers in 2017, 2016… you get the message, I think. Consistent, these funds ain’t.
If I was an investor looking to pick a fund using my earlier definitions, I’d probably go and look at the Strategic Bond funds sector. Here there is much more consistency of positive returns amongst the top tier. In 2018 of the top 10 strategic bond funds, two (nearly three) had consistent positive returns over the last five years, six in the class of 2017 and five in the class of 2016.
Now I realise I’m cherry picking from past performance but all I can say is that when I turn my attention to year-to-date numbers for 2019 (just one month, mind), the picture doesn’t get any better with H20, Sanditon and GAM Star Discretionary all notching up losses to date. Odey by contrast is on a tear as are the BlackRock funds (Emerging Markets Absolute and Global Long/Short Equity).
My bottom line? I genuinely think that absolute returns as a solutions-based fund structure has an important place in portfolio construction for many defensive investors and there are clearly consistently excellent managers working in this space – I would highlight H20 (connected to Natixis), Odey, Sanditon, BlackRock, Newton and Artemis.
But based on recent returns I’d suggest that investors haven’t been rewarded for increased volatility. In those circumstances perhaps strategic bond funds might be a safer bet – assuming of course we are not on the receiving end of a bonds rout in the next year or so!
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