Volatility in bond and equity markets has picked up lately, and risks seem to be cropping up in every part of the globe. Now investors are turning to absolute return funds – which aim to create returns in rising or falling markets – for safety.
At the moment, many investors are finding it tricky to find good opportunities. There are two key issues facing investors at the moment: that equity markets in the US and UK are considered expensive, and bonds are not good value, says Clive Hale of Albemarle Street Partners. In this environment, “absolute return funds do have an attraction,” he says.
On the flipside, gold and other commodities have fallen to rock bottom levels, and most bonds are giving investors terribly poor value.
Added to this, the first post-crisis interest rate rises are on the cards in the US and the outlook for markets is more uncertain than it has been for years. Some believe rate rises will cause a sell-off in blue chip equities. In response, equity markets have been very volatile, making large swings from week to week.
Many fund managers have chosen to sell down some equities recently, preferring to take profits and hold cash instead until better opportunities arise.
But another option is absolute return funds. Inflows into these funds have reached record levels this year, according to the Investment Association. At the end of a bull market, investors are looking for instruments which will be uncorrelated with bond and equity markets, and will hold up during choppy times. Moreover, after six years of asset price growth, it is harder for long-only managers to outperform.
Historically the preserve of specialists and institutions, absolute return funds use a range of techniques to try and make money in all market conditions, with lower volatility.
“These funds are appropriate as volatility is coming back. We are entering a period of interest rate normalisation and markets will continue to be volatile,” says Eric Verleyen of Societe Generale Private Banking.
Over the last decade rules have been relaxed and there is a wide range open to ordinary investors. Savers will not make a huge amount of money with absolute return, but they can help preserve capital and, if things go to plan, they will eke out reasonable returns whether markets are moving south or rising positively.
One reason for putting your cash into an absolute return fund at the moment is, because some experts think the current environment is so uncertain, people should be extra diligent about diversification.
“The next thing for markets will be normalising interest rates,” says Verleyen. “If you are not diversified enough… you will not reach your return targets.”
Over the last five years, the average absolute return fund has made a return of 18 per cent, according to the Investment Association. They are normally benchmarked against cash, which has risen 1.8 per cent over that time.
However, funds in this category vary enormously. Some are focused on just bonds or just equities, while some are invested across a wide range of assets.
Many use specialised tools including hedging or shorting the market to make money in downturns. “You really have to do your homework,” says Hale.
Absolute return has had a poor public image, as historically many funds have failed to deliver. But since there are many separate sub-categories of fund grouped under the absolute return banner, many strategies are simply incomparable. Funds ought to be assessed on an individual basis, depending on the risk level the investor is comfortable with.
“They are often misunderstood, as they can appear more complicated than many would like. Some are complicated, but others are quite simple,” explains Darius McDermott of FundCalibre. “Absolute return funds are a very good portfolio diversifier and an option for investors who may be worried about markets.”
He emphasises that investors should think of absolute return in terms of beating cash, rather than beating the market. “These returns will be on a rolling basis, as you are not guaranteed positive returns every day, but over 12-36 months, depending on the fund,” McDermott says.
He highlighted the Smith & Williamson Enterprise fund, a long/short equity strategy which invests primarily in the UK. Another choice is the Church House Tenax Absolute Return Strategies fund, which is multi-asset and targets a return of 4 per cent plus Libor – a not insignificant amount in today’s low return world.