Multi-asset managers have embraced absolute return funds, which they consider crucial to help protect investors’ money.
Guillaume Paillat, multi-asset portfolio manager at Aviva Investors, said they are a core holding in most of its multi-asset portfolios. ‘Given their low correlation to traditional asset classes, absolute return funds are useful diversifiers,’ he said.
He believes this is particularly relevant in the current context of increasing equity and bond market correlation. ‘They’re unconstrained, so they are free of any benchmark ties,’ he said. ‘This lets them invest in assets classes where they believe they get the best risk-adjusted returns.’
Paillat says a strong investment process, with an emphasis on portfolio construction, is key to a successful absolute return strategy. ‘We closely watch their performance in volatile markets: this is the true test of a fund’s capability,’ he said.
He also focuses on liquidity. ‘Funds should be liquid in good and challenging times,’ he said. ‘After liquidity comes transparency: we need to understand what it’s doing.’
Camilla Ritchie, senior investment manager at Seven Investment Management, also likes absolute return funds’ ability to deliver positive returns in weak market environments. ‘If managed well, they can deliver strong returns that aren’t linked to markets,’ she said. ‘This can help smooth performance and returns for investors.’
On the downside, Ritchie suggests some absolute return funds can be unnecessarily complex. She would like to see more transparency from them regarding underlying strategies. As a result, she tries to avoid opaque ‘black box’ funds and those with overly onerous fee structures.
Funds and fees
Adrian Lowcock, investment director of Architas, also uses absolute return funds. He insists downside protection is an essential part of successful long-term investing. But he acknowledges they come with issues.
‘The performance fee is unattractive. It’s usually on top of existing management fees, making the overall cost expensive,’ he said.
He also points out many of these funds do not target equity-like returns, but cash-plus returns. And additional fees eat away at what the investor gets back. ‘The sector is also a mix of different funds, investing in a range of assets and using a variety of strategies,’ he said. ‘So it’s hard to compare like with like.’
Indeed, Lowcock points out the sector contains funds targeting a total return as well as those focusing on capital preservation. This makes it dangerous for investors.
‘Depth of talent and resources in the management team is essential when considering these funds,’ he said. ‘Consistent long-term performance is also important, as this should prove the strategy of the fund and the team.’
Andrew Merricks, head of investments at Skerritts, is more downbeat. ‘It’s not a favourite sector of mine,’ he said. ‘We’ve used them in the past. But generally we avoid them, as they’ve let us down.’
Merricks said volatile market environments are problematic for absolute return funds, as they often catch the downs more than the ups. ‘In such periods, there’s no point in losing money. Instead, you can hold cash that will give you the opportunity to buy back in when you’re ready,’ he said.
Although burned by past bad experiences, some funds have delivered on expectations. Skerritts holds the Church House Tenax Absolute Return Strategies fund, run by Citywire + rated duo James Mahon and Jeremy Wharton; and the Artemis US Absolute Return fund, run by AA-rated Stephen Moore.
Absolute return funds can also be a substitute for unattractive asset classes such as gilts, according to Chris Fleming, investment services director of Square Mile Investment Consulting. He looks for funds that can perform without a reliance on market beta.
‘This requires an edge to generate an alpha,’ he said. ‘I also see if the manager has an investment philosophy and process consistent with this alpha generation aim. Funds that meet our criteria are hard to find.’