Not an absolutely real return

Fewer than half of all absolute return funds have provided investors with a real return – over and above inflation – in the past year, new research has revealed. But analysts still believe that, if carefully selected, some can still generate low-risk positive returns over the long term.

In a study of the Investment Management Association’s Absolute Return fund sector, published this week, FE Analytics found that just 43 per cent of funds beat inflation in the 12 months to June 30. Of the 56 funds with a 12-month performance history, only 24 returned more than inflation on the retail prices index (RPI) measure, which stood at 5 per cent in June. A further 3 funds beat consumer prices index (CPI) inflation, which fell to 4.2 per cent in June. However, 29 out of the 56 funds – 52 per cent – lost money in real terms. According to FE Analytics, even more funds failed to keep up with inflation when charges were taken into account.

These findings follow a warning last week, from rating agency Fitch, that absolute returns funds are at risk of being mis-sold to investors seeking a guaranteed return on their capital.

Nevertheless, analysts say the number of underperformers reflects the differing strategies of funds in the sector. “The problem with the absolute return sector is that it comprises a diverse group of funds, each of which have different objectives in terms of return targets, volatility profiles, and time horizons,” says Rob Crawshaw, assistant director of Brewin Dolphin Fund Research.

Many suffered as a result of holding the wrongs assets at the wrong time, argues Brian Dennehy managing director of advice firm Dennehy Weller & Co. “The funds achieve their objectives in different ways: bonds, equities, multi asset,” he points out. “Because of the different approaches, you have to consider where we are in the cycle, and which asset classes might be more likely to outperform at this stage. Some are surprisingly volatile, others marvellously lacking in volatility and achieving decent returns, such as Insight Absolute Insight.”

Funds that maintain large cash holdings, to help hit cash-linked performance targets, have suffered most. “Many of the funds benchmark against cash, so it is unsurprising in certain cases to see underperformance against both RPI and CPI, as inflation has consistently remained above base rates over the past 12 months,” explains Crawshaw.

Even funds that rely more on long and short equity positions can be held back by cash, argues Mick Gilligan, head of research at broker Killik & Co. “Most long/short books have a large cash position with [equity] exposure taken via derivatives. We are in a period of historically low rates so, in some cases, the higher than average fees on these products have had a greater negative impact than in times when higher levels of interest accrue.”

Some argue that absolute return funds need to be judged over a longer time frame. “It may be that the manager is positioned for a set of market conditions that have not transpired yet,” says Gilligan. “If his or her thesis plays out, the upside could be significant.” Dennehy agrees. “You must look over longer periods, and identify what funds work best in distinct points of the cycle.”

For these reasons, private investors are advised to research a fund’s holdings and objective before committing their capital. “I’m not a fan of the sector per se – but there are a small number of gems within it,” says Dennehy.

FE Analytics found that the best performing funds over the past year were CF Odey UK Absolute Return, up 38.72 per cent; GLG Emerging Markets Equity, up 29.79 per cent; and Cazenove Absolute UK Dynamic, up 28.95 per cent. Dennehy is wary of this outperformance, though. “It is very important to understand what is driving such outperformance, and whether this will lead to an equally marked volatility on the downside,” he explains. “The absolute return sector is not one where you should be greedy, as you will probably end up chasing the shadows of past performance.” He prefers the Insight fund, as well as those from Newton and Ruffer.

Gilligan at Killik & Co is more impressed by listed, or ‘closed-ended’, funds. These were not included in the FE Analytics study, but more than half have succeeded in beating inflation. Of 36 listed funds aiming for absolute returns, 19 outperformed both RPI and CPI in the 12 months to June. Of these, the top performer was Third Point Offshore, up 51.5 per cent, which Killik recommended last August, and BlackRock Hedge Selector UK Emerging Companies, up 20 per cent.

Even so, advisers warn that many absolute return funds can be volatile – and recommend combining a selection to limit risk. “Ideally, you would have a blend of absolute return funds and bond funds across the market cycles, which you would monitor closely,” says Damien Fahy at Dennehy, Weller & Co. Monitoring is key before and after buying, says Crawshaw at Brewin Dolphin. “Absolute return strategies can still offer an element of diversification and reduce a portfolio’s volatility, but we remain mindful of how inflation can impact real returns – highlighting the importance of fund analysis and selection.”