Absolute return funds have suffered an absolute beating in the media in recent months.
From reports of widespread underperformance, to the stunning liquidation of the £5.8 billion GAM absolute return bond fund range and, of course, the never-ending story of outflows from Standard Life Aberdeen’s (SLA) Global Absolute Return Strategies (Gars) fund, the sector has enjoyed some unwanted press.
But despite the negative headlines, IFAs are largely sticking by the sector.
Advisers still remain drawn to their potential to diversify portfolios and provide low-correlated returns. The need to have portfolio diversification is considered all the more important by advisers worried the market’s long bull run is coming to an end.
The question is whether these funds really are the best way to mitigate volatility and provide protection from a downturn, or whether less expensive and more effective options are available for IFAs.
Kicking the asset class?
Cheshire-based advice firm Equilibrium Asset Management has big holdings of absolute return funds in its cautious and balanced portfolios. This includes the Janus Henderson UK Absolute Return fund, the Invesco Global Targeted Returns fund and the LF Odey Absolute Return fund.
Neal Foundly, an investment analyst at Equilibrium, said the firm is maintaining its exposure to these absolute return funds despite the negative publicity with GAM and Gars.
‘It is easy to kick an asset class when it is down and has issues. The issue with Gars is said to have been because it has become such a large fund. That is completely understandable and there are similar situations in other asset classes,’ he said.
‘I think it is just a confluence of events in a number of funds within this sector. I don’t think it writes the sector off by any means and it still serves its role.’
According to Foundly (pictured above), absolute return funds are important because they provide uncorrelated returns. These are more valuable as markets become more volatile: something we are seeing in 2018 with interest rates on the rise and global equity markets facing heightened uncertainty.
‘The low volatility we saw in the equity markets last year has been an issue for some of these absolute return funds,’ he said. ‘Volatility inevitably kicks up opportunity and these guys can drive returns on the back of that. Whereas if you have flat markets that don’t kick up those undervalued opportunities, they are not going to drive good returns.’
Charles Chami, director of Bristol-based Glamis IFA, said his firm started using absolute return funds as a replacement for bonds, which have seen their prices heightened by years of quantitative easing (QE).
‘Post-QE, with bond prices being as high as they are, that allocation didn’t feel as defensive as it once did. We started allocating to absolute returns to fill a little bit of that lower volatility requirement,’ he said.
Chami uses the JP Morgan Global Macro Opportunities fund. The fund (UK and Jersey domiciled) is now 3/39 in Citywire’s rankings for the Alternative UCITS - Multi Strategy sector over one year, returning 6.09% and 5/25 over three years, returning 8.86%. He pairs this with the Janus Henderson UK Absolute Return fund (34/68 in the Alternative UCITS - Long/Short Equity sector over the same period) to provide diversification and low correlated assets.
‘I believe this sector offers diversification and it definitely has a place in a portfolio,’ Chami added.
The worst-ranked fund was Odey Odyssey, which lost 45.8% over the past three years. The sector average in the Alternative UCITS Multi-Strategy sector was a loss of 0.4%, pointing to general poor performance recently. The best over three years is the Veritas Global Real Return, returning 38.17% (see graph below).
Citywire data for 39 funds in the Alternative UCITS Multi-Strategy sector we track found the assets fell over the 12 months to July 2018 from £51.4 billion to £48.5 billion. The drop in value of £6.8 billion is attributable to poor performance.
But despite flagging returns, the sector saw net flows of £3.9 billion for the same period across these funds. This suggests IFAs are still sticking with them.
One high-profile absolute return fund that has struggled to keep business has been SLA’s Gars fund, which saw another £5.3 billion leave the fund range in the first six months of 2018.
RBC Capital Markets said in a note last month Gars’ outflows would quicken and predicted a whopping £21 billion could leave the range over the next three years.
A spokesman for SLA said its recent upturn in returns means the firm expects flows to ‘normalise’ soon.
‘Gars remains a highly compelling proposition for which there remains significant client demand,’ the spokesman said. ‘Improved performance should feed through to a reduction in redemptions over time.
‘Given multi-asset remains a fast-growing market segment and the strength of the franchise Aberdeen Standard Investments has established in this field, it is not unreasonable to assume a return to a more normalised flow profile over time.’
The performance of Gars has indeed picked up, with the fund turning positive in July. But it currently sits 30th out of 39 funds in Citywire’s sector rankings over a one-year period and 21 out of 25 over three years.
Nathan Fryer (pictured above), director of paraplanning firm Plan Works, said he had noticed IFAs selling out of Gars but has not seen an exodus from other absolute return funds.
It is right for advisers to stick with their absolute return funds now, according to Fryer, because markets are making the need for protection likely.
‘I do think it is right [people are not selling out] because we have rising interest rates and equity markets around the globe are at an all-time high, so there isn’t anywhere to hide,’ he said.
‘I’m not trying to call the market, I don’t think anyone should, but there are concerns about this bull run. It is just to make sure you have the right defensive plays in place.’
Poor performance is not the only criticism to have been levelled at absolute return funds. The sector has also been attacked for the funds’ complicated structure and high charges.
Phil Loney, chief executive of mutual insurer Royal London, told New Model Adviser® last month products that use derivatives ‘look very expensive’.
There are other options for IFAs seeking to negate volatility. The PruFunds range, which uses a smoothing mechanism, has proved incredibly popular among IFAs seeking low volatility options. The fund has now grown to £40.3 billion in assets.
However as Loney points out, PruFunds is also an ‘expensive’ option for advisers. Earlier this year Pru cut the PruFunds annual management charge from 135 basis points to 120, for funds held in an ISA.
Advisers with clients in drawdown are particularly wary of sequencing risk, whereby early bouts of poor performance can hobble the fund for years afterwards.
Another way to manage this risk, according to Lawrence Cook, director of marketing and business development at Thesis Asset Management, is to sell out of cash and bond pots before equities.
Cook said the absolute return sector ‘has not been able to deliver consistent level of real returns coupled with low volatility that the clients and advisers hoped for’.
To dampen volatility, particularly for clients moving into drawdown, Cook said IFAs can sell out of stable assets first and save volatile assets such as equities for later.
‘If you focus on selling first assets that naturally exhibit low volatility, like cash and bonds in early years, and equities later, the things that don’t go up and down so much are not suffering from sequencing risk,’ he said.
‘You are not selling equities and you are leaving those to recover and hopefully grow over the medium to long term. That seems like an eminently sensible strategy.
He added: ‘Absolute return funds still have their place, but as an ingredient in the mix and not the panacea.’