Absolute return funds: Is this the best of all possible worlds?
A promise of profits without risk. Kate Hughes is slightly sceptical
Saturday 29 March 2008
For most of us, talk of economic downturns and recession means a flight to financial safety. We batten down the hatches while the storm rages around us. For investors, while this strategy means that they don't lose anything, they don't make anything either. So the possibility of making money in a falling market with little risk can be intoxicating.
Absolute return funds claim to offer this elusive prize: good performance for low risk in any kind of economic climate. They aim to make you money regardless of whether the markets rise or fall. But actually achieving this is a very tall order, and most absolute return funds have struggled to deliver.
SLOW AND STEADY?
Although they only burst on to the scene three years ago, thanks to a change in derivatives regulation, the variety of absolute return funds out there today is daunting. The goal of all of them, however, is the same: to make steady, positive returns, whether the markets are falling or rising.
Scottish Widows Investment Partnership's Absolute Return Bond Fund( www.swip.com/absolute_return) and Threadneedle's Absolute Return Bond Fund ( www.threadneedle.co.uk), for example, try to protect their funds by investing only in bonds and cash. They are far less volatile than their peers, but the performance enjoyed by their investors is also limited.
The Swip Absolute Return Bond Fund aims to deliver, over the long term, the equivalent of just 1.5 per cent per annum above the Bank of England base rate, after fees and taxes. "The fund aims to offer a low-risk strategy, using bonds and cash to produce positive absolute returns," says Craig Inches, manager of the Swip fund. "It is a fund for lower-risk investors looking for cash-level returns, but with exposure to bond markets."
He acknowledges that the returns aren't great compared to direct investment in equities, but says that investors must be realistic about the relationship between risk and reward. "Investors assume that equities provide higher returns," he says. "But they come with higher levels of risk. And if you have a bad year, it can be a very bad year." Over 10 years, he suggests, absolute bonds can offer returns that are "not that far away"from equities expectations, but with a small fraction of the risk.
Some absolute funds spread themselves across a huge range of asset classes in an attempt to reduce the effect of volatility in one sector or region. The more diversified your fund is (the thinking goes), the lower the risk – if one sector drops, you can fall back on others to minimise the loss. For example, the Mellon Global Absolute Intrepid fund, run by Newton ( www.newton.co.uk), has holdings in UK, US and Japanese equities, as well as fixed interest and cash. According to Mellon, the fund has returned 95.98 per cent over the past five years, against a sector average of 64.96 per cent.
HEDGING YOUR BETS
Other absolute funds employ more complex approaches in a bid to offer less risky returns to investors. In 2004, a regulation overhaul meant that regulated funds could use "short-selling" techniques, allowing funds to gain from drops in markets as well as rises.
Managers "short" the market by borrowing stock, selling it, and then buying it back once it falls. Funds that use this technique tend to have the most reliable performance, says Andrew Wilson, head of investments for the financial adviser Towry Law. "The manager has to be a good one, though, and BlackRock's UK Absolute Alpha Fund ( www.blackrock.co.uk), run by Mark Lyttleton, is one of the best," he says. Lyttleton's fund has returned 12.5 per cent over the past year, during which time the FTSE 100 has fallen more than 5 per cent.
Although the FSA won't allow managers to disclose information on their short positions because of the potential damage it could do to those companies, Lyttleton's top 10 long positions include easyJet, BAE Systems, and the Mediterranean property development company Dolphin Capital. BAE, for example, has seen its shares rise by more than 8 per cent over the past year, even as the markets have been falling.
DO THEY HAVE A PLACE IN YOUR PORTFOLIO?
In all their various guises, absolute return funds are aimed at cautious investors looking for low-risk funds to form the foundation of their portfolios, and investments can be made from as little as £50 per month. But the verdicts on most absolute funds have been far from positive.
"Absolute return funds have frankly been an embarrassment," Andrew Wilson warns. "They have almost uniformly failed to deliver – along with their close cousins, target return funds. They may have diminished risks, but they have almost entirely evaporated returns at the same time."
He also warns that assessing a fund's performance against others is virtually impossible because they are all so different. There is no absolute return sector like UK All Companies or Cautious Managed sectors, and absolute return funds are benchmarked against a variety of different sectors based on the underlying holdings. This makes it very difficult to determine decent performance because the funds are all measured against different yardsticks. And investing in absolute returns will usually match other, higher-yielding vehicles, often with an initial fee of 5 per cent and annual management charges of 1.5 per cent or more.
Meanwhile, investors are also expecting the best of both worlds when it comes to performance and risk, adds Philippa Gee of the financial adviser Torquil Clark. "Investors have become disillusioned by absolute return funds because of poor performance," she says. "But they don't make the connection between returns and risk. You can't have everything, but investors expect more than they are getting from absolute funds. They also assume an extra level of security which is not necessarily there."
"Investors just don't need these funds to protect themselves from volatility in the markets," says Wilson. "By using the correct asset allocation, investors can manage their investments in difficult periods without resorting to absolute return funds."
"Those who are concerned about the effect of a downturn in the economy and a bumpy rise for the markets should put 30-40 per cent of their investments in cash, and then look at spreading their investments in equities," adds Gee. "The golden rule is not to invest in a name or trend, but to invest in what is right for you as an individual."
The experts' favourite absolute return funds
"Investors become fixated on positive returns when stock markets are falling around their ears," says Keith Thompson of financial advisers Blackadder. "Absolute return funds fill a niche in the private investor marketplace. Providing that investors understand their limitations, these funds can give peace of mind that they should provide steady, consistent, positive returns for the cautious investor (as long as the fund manager delivers). Absolute return funds sound like the ideal solution, but these funds are likely to underperform a rapidly rising market."
He notes that the majority of managers have not met their fund objectives over the last year, and he urges investors to choose carefully. "I prefer the BlackRock UK Absolute Alpha, Insight Diversified Target Return, SWIP's Absolute Return Bond and the Arch Cru Income Portfolio funds," he says. "I use each fund in different proportions to cover a wide range of asset classes.
"But the success of these funds is highly dependent on the fund manager's skill. In fact, this may be one asset class where investors would do well to follow the fund manager in the future rather than the fund itself."
John Davey, a research analyst for the investment adviser Bestinvest, also recommends the BlackRock UK Absolute Alpha fund, and adds Dexion Trading, a "macro" hedge fund, so-called because it aims to profit from changes in global economies. "The volatile environment we are currently seeing should benefit macro managers, who have the biggest arsenal of markets and instruments to trade," he says.
He says that Thames River Hedge + is worth considering too. Though one is always warned that past performance is not an indicator of future success, he notes that "the fund's performance over the last year has been strong, and was driven by three of the underlying managers being short of sub-prime."
- 1 Autistic teenager beaten up by bullies makes them watch 20-minute video about autism
- 2 Greece debt crisis explained: A history of just how the country landed itself in such a mess
- 3 People all over the world are getting semicolon tattoos to draw attention to mental health
- 4 Greek debt crisis: Yanis Varoufakis's funniest (and most memorable) quotes
- 5 Swedish minister gives strongest case yet on why EU should stop turning away asylum seekers
More Britons believe that multiculturalism makes the country worse - not better, says poll
Osborne to cap family benefits at £23,000 – announced ahead of his post-election Budget
Nathan Collier: Montana man inspired by same-sex marriage ruling requests right to wed two wives
Forget little green men – aliens will look like humans, says Cambridge University evolution expert
Girl, 7, stares down hate preacher at Ohio festival with pro-LGBT rainbow flag gesture
Sickness and disability benefits could be reduced by £30 a week as part of £12bn welfare cuts
iJobs Money & Business
£40000 - £95000 per annum: Recruitment Genius: This is an exciting opportunity...
competitive: SThree: Are you passionate about sales?Do you have a keen interes...
£17000 - £30000 per annum: Recruitment Genius: This is an exciting opportunity...
£15000 - £17000 per annum: Recruitment Genius: This company offers a range of ...
Day In a Page
This three-bedroom stone-built cottage currently trades as the village store with a restaurant in the annexe and family accommodation on the upper floors.
Previously two semi-detached properties, this five-bedroom home is spread over three floors with a large breakfast kitchen, orangery, office and gym on the second floor.
This five-bedroom home enjoys countryside views over the Blyth estuary to Southwold, offering flexible living space with a ground-floor annexe - ideal for use as a holiday let.
Close to the market town of Eye, this four-bedroom detached home offers a double-height living room which takes the place of the original, 19th-century, chapel nave.
Dating back to the 19th century, this four-bedroom home needs modernising. Spanning three storeys, the red-brick house has a fireplace, a small terrace and a cellar.
Just outside of Cambridge, this single-storey home offers three double bedrooms, a living room with vaulted timber ceiling and ladder steps that lead to a mezzanine study area.
This six-bedroom Georgian home is on three floors with open fireplaces, a two oven Aga, an annexe, and cottage gardens with outbuildings and a car barn.
A former coach house, Glebe Farm Stable is now a three-bedroom cottage with a double car barn, an attached office, kennels and an outbuilding that's currently used as a gym.
Located beside an impressive Victorian viaduct, this four-bedroom home has an open-plan living area that is glazed on two sides, with skylights and high ceilings.
A former furniture workshop, this three-bedroom home has high ceilings and painted brick walls, in a village setting only fifteen miles from the coast.
This five-bedroom stone townhouse features a pine staircase and an Inglenuk fireplace, double doors from the lounge give access to an enclosed courtyard.
This five-bedroom, detached home blends traditional and modern design; the sleek kitchen features a gas hob and oven set within an exposed chimney breast.
Moored in Chelsea's Cheyne Walk, this houseboat offers two double bedrooms and a teak deck that's ideal for al-fresco dining.
Surrounded by woodland, this five-bedroom manor house has plenty of outdoor storage space in the form of three converted loose boxes, two smaller outhouses and a woodstore.
This six-bedroom home is set amongst three acres of grounds. Currently a large family home, Clift Hill has potential to make a B&B or countryside retreat, subject to change of use permissions.
This Grade II-listed three-bedroom home is situated on a private road, just a short walk from the sandy beaches of Frinton-on-Sea.
Less than five miles from Malmesbury, this four-bedroom cottage comes with equestrian facilities and gardens that extend to approximately three acres.
Spanning three storeys, this late-Victorian five-bedroom farmhouse is a spacious family home with a modern interior and B&B potential.
With an original church arch, this triplex one-bedroom church conversion has a light, spacious, feel and comes with a secure off-street parking space.
This recently-refurbished three-bedroom home has bi-folding doors that lead out to a decked seating area - ideal for alfresco dining this summer.
Well-located for coastal walks and popular restaurants, this detached four-bedroom home offers views over farmland, to the Solent, the Purbecks and Bournemouth.
If you love high ceilings, school conversions like this one are bang on the money. This two-bedroom flat is minutes from Burgess Park and the foodie haven at Borough Market.
Set within a church conversion in Bermondsey, this two-bedroom maisonette combines existing features, such as original arches and brickwork, with a contemporary finish.
In the pretty market town of Bungay, this grade II-listed Mill House is arranged over four floors, offering four bedrooms and three reception areas.
This four-bedroom Edwardian home offers a combination of original features and contemporary design after a renovation by the current owners.
This four-bedroom home offers a vaulted ceiling in a breakfast room that's ideal for summer entertaining with doors that open to the patio and garden.
On the market for the first time in more than 50 years, this six-bedroom home is a project with vast potential - spread over three floors of living space.
This five-bedroom home comes with a range of outbuildings including a large barn which could be converted into a self-contained granny-flat or rental.
Surrounded by rolling countryside, this four-bedroom barn conversion comes with a self-contained, one-bedroom annexe that could serve as an office or a holiday let.
Located near Harrogate town centre, this five-bedroom Victorian terrace is arranged over three storeys while a current study serves as an optional sixth bedroom.
A ground-floor flat in a country house, located a mile from Sway; this two-bedroom home would make an ideal weekend retreat on the edge of the New Forest.
On a popular residential lane in Caterham on the Hill, this four-bedroom family home offers a secluded garden and a convenient location for local schools and public transport.
Just a short walk from Westerham green, this three-bedroom cottage has a light kitchen with exposed brickwork and double doors that lead to a south-facing garden.
In a prime spot opposite the River Thames, this one-bedroom flat has an 18sq ft reception room with glass doors that open out to a private terrace.
Set in the hills above Llanwrda Village, west Wales, this 18th-century three-bedroom farmhouse has holiday-let potential from a separate barn conversion and annexe.
This charming end-of-terrace townhouse is arranged over three floors, with two double bedrooms and a private courtyard garden located at the rear of the property.
Located in the University area, this semi-detached five-bedroom home is arranged over three floors - there's even a rear garden and off-road parking too.
Only a few minutes' drive from the charming town of Marlow, this two-bedroom home sits on the private riverside estate of Harleyford.
This detached four-bedroom home in Middleyard is arranged over two floors, with features that include a wood-burning stove and bespoke oak staircase.
In a row of eight detached Georgian residences, this five-bedroom home offers views of The Sound, Mount Edgcumbe and Cornwall from its impressive veranda and full-length balcony.
If you love cooking for friends this two-bedroom flat - complete with views of the iconic Battersea Power Station and an open-plan kitchen/dining area - will go down a treat.
Located above Grasmere village, this five-bedroom home is arranged over three floors and offers countryside views across Grasmere Lake towards Silver Howe.
This four-bedroom detached home comes with a double carport, useful workshop, garden and two walkways that offer views of the adjacent countryside.
With space for an equestrian business, a greenhouse for growing your own veg, a wine store and a gym; this five-bedroom home has all the ingredients for a country retreat.
The decked roof terrace of this two-bedroom flat is perfect for summer drinks while large windows and ample storage space make for a light and spacious interior.
Set sail for this four-bedroom farmhouse in Cowes. With five acres of land and an indoor pool, this home oozes character. There is even potential to let a one-bedroom annexe.
Surrounded by approximately 15 acres of grounds, this six-bedroom grade II-listed home has been extensively refurbished yet retains many period features.
This four-bedroom home comes with a two-bedroom cottage and commercial office, with planning to extend, in a stunning courtyard setting.
In a pretty Norfolk village, this four-bedroom family home is surrounded by landscaped gardens, with even a self-contained annex for guests.
A few miles from the seaside at Perranporth, this four-bedroom farmhouse sits amongst nine acres of idyllic grounds - including a lake and two barns used as holiday lets.