Absolute return funds, through good times and bad

Brian Dennehy

Quick review – absolute return funds over different cycles

Everyone wants maximum returns with minimum risks. In the real world it doesn’t work like that. With-profits funds offered stockmarket-style returns over the long term but were shown to be fatally flawed through a prolonged downturn.

The advent of “absolute return” funds promised something new: low volatility, better-than-deposit returns, and day to day liquidity (unlike with-profits). But they are not funds for all seasons. Put another way, some absolute return funds work well in certain kinds of markets, some in others – none perform well in all markets (though it does depend on how you define “perform well”).

The range of such funds achieve their returns in a variety of ways; we might classify them as focussing on one of equities, bonds, or multi assets. This makes them sound straightforward. The reality is somewhat more complex as all such funds will probably make extensive use of derivatives, which can sharply skew the risk and reward profile, and cannot be easily tracked by investors and advisers on a regular basis.

We have looked at four funds with a range of approaches, and long-ish track records (at least for this young sector):

• BlackRock UK Absolute Alpha                    UK equities
• Newton Real Return                                     multi asset
• Threadneedle Absolute Return Bond        global bond
• Baring Absolute Return Global Bond         global bond

We have broken down four periods since the last of these funds was launched:

1. 24/10/05–08/08/07. Last leg of equity bull run
2. 09/08/07–31/08/08. Credit crunch 1, calm 
3. 01/09/08–28/02/09. Credit crunch 2, storm
4. 01/03/09 to date. Recovery.

TABLE 1 – performance in each period

The BlackRock fund did extremely well in period 1, as you would expect, but the performance in period 3 is particularly impressive, plus the return made in the period of relative calm.

The divergence between the two bond funds in different periods is interesting, and not something that investors could easily have anticipated – though the table below perhaps makes clear that the Baring fund is prepared to take more risks, and that the Threadneedle fund would be preferred in a period of growing and extreme uncertainty.

The Newton fund, although multi asset, tends to have a long term bias to global equities, but will make big switches to cash and fixed interest. For example, it was 30% in cash ahead of the worst problems in Autumn 2008. As such the Newton fund should be compared as much to a global equities index as its absolute return peer group – such a comparison illustrates the managers success more obviously, for example outperforming the world index by 13% over the last 3 years. But the recent recovery phase also highlights how it can underperform global equities when the house view remains cautious.

Here are the key statistics over the whole period:

TABLE 2 – key statistics 24^th October 2005 to 12^th August 2009

Perhaps no surprises in the above table but for BlackRock with low maximum drawdown and negative months, and monthly volatility lower than the Baring bond fund.

A few conclusions can be drawn:

• In choosing absolute return funds you still have to engage brain!
• You must understand how each fund works, which isn’t easy – apparently similar funds can perform quite differently
• If you wish to fine tune your choices you must identify the current market cycle (or the one just ahead) with some accuracy (not easy)
• You must have a blend of absolute return funds, and monitor closely
• Buy and hold is unlikely to be very successful, even with a blend. You must pay attention to unfolding performance

In addition the BlackRock fund highlights that some fund managers are particularly skilled at this sort of fund – shorting (down bets if you like) is psychologically difficult and few are successful; the manager of this fund is one of the exceptions. This means you must be particularly vigilant as individual managers can go off the boil (they are human!), or move on to pastures new.

Print  Refer a friend