Absolute return funds continue to attract plenty of interest from investors and the providers of wealth solutions. Thomson Reuters Lipper global fund market statistics show a marked trend of increasing cumulative sales in such funds from €58.97m (£49.8m) in 2003 to over €21bn (£17.7bn) today.
However, despite their popularity, absolute return funds have come under fire in recent years for failing to meet objectives and the way their fees are structured. Unsurprisingly, our data shows there are good and bad absolute return products. For example, over the three years to the end of October 2016 the Kames Absolute Return Bond fund’s worst weekly loss was a mere three basis points. On the other hand, one absolute return fund managed to lose 7,800 basis points in a single week. No absolute return funds recorded positive returns for the entire period.
Absolute return funds are not generally compared with market returns as they do not intend to behave like the market. Common in fund prospectus language is a stated aim of positive returns over inflation or the risk-free interest rate. The target time period to achieve this can vary; one and three years are common, as is nonspecific terminology such as over the medium or long-term.
It is quite straightforward to quantitatively assess the performance of an absolute return fund. We start by looking at growth over one or three years because these periods are popular. Next we need a measure to assess the risk of loss avoidance, which is crucial to the investor in absolute return funds. For simplicity, we use a red flag risk indicator: the absolute maximum weekly loss. This is a straightforward assessment of the worst percentage negative total return in any sub period, for example, 12 months has 52 weekly sub periods. The maximum weekly loss provides clearer warnings of failure to live up to the promise of absolute return. The average loss over a number of sub-periods could have alternatively been used but this measure is less effective as a warning indicator due to the smoothing of the returns.
Consider a car battery with a hidden electrical defect that never actually fails. It was always defective and always more likely to fail than a sound battery; we just could not know by observation alone. Historical measures of fund returns do not predict the future, but they do tend to reveal useful insights into the underlying truth of a fund strategy.
First, we analysed sterling-denominated Ucits funds only sold in the UK, selected from a combination of the Investment Association’s Targeted Absolute Return sector and Lipper’s Absolute Return and Alternative sectors. With these filters there were 102 funds in the group with one-year returns and 75 funds with three-year returns. The table shows the top 15 funds ranked by their total return divided by the maximum weekly loss indicator – the growth/loss ratio.
Funds that target returns over a one-year period feature well in the one-year year table, with many of the top-performing funds over one year also ranked in the top 15 over three years. Notably, the SVS Church House Tenax Absolute Return Strategies fund, ranked third over one year and second over three years. The fund managed to avoid any weekly losses over 1 per cent and still provided investors with a total return of 14.6 per cent over the three-year period.
In the three-year table, funds that targeted returns over three years or more tended to deliver good results, as expected. The GAM Star Credit Opportunities fund recorded a 31.5 per cent three-year net return with a maximum weekly loss of 1.4 per cent. Of the top 15 in both time periods, only three funds were equity mandates. These were the Henderson UK Absolute Return fund; Old Mutual Global Equity Absolute Return fund and the BlackRock UK Absolute Alpha Equity fund. Unconstrained bond and multi-asset strategies dominated the top 15.
The second part of the analysis looks at the growth/loss ratios across some other IA sectors. We then compared the maximum, minimum and average ratios in each IA sector with the first set of results from the mixed set of absolute return funds. It is interesting to apply the concept of maximum loss as a common risk measure against both relative return and absolute return funds. This is an attempt to answer the question – how might an absolute return investor have fared in a relative return fund over the same period?
The following IA sectors were therefore analysed in exactly the same way as the absolute return funds: UK All Companies; £ Corporate Bond; Flexible Investment and Property. These were chosen due to their diverse underlying asset profiles.
The GAM Star Credit Opportunities fund, one of our absolute return funds, scored the maximum ratio over three years with 22.4 – a statistic not matched in any of the other sampled sectors.
However, overall, the IA £ Corporate Bond sector recorded the best average growth/loss ratios over one year and three years. The average value of 10.16 over three years was significantly higher than in any other sector, for example, absolute return funds scored only 4.57 on average – the third highest score, with property sector second at 6.05. This lower average score over three years from the absolute return funds is partially explained by the following: the sector contained five poorly-performing funds rec-ording growth/loss ratios of <-1: lower figures than any fund in any of the other sectors. Evidence perhaps that investing in an absolute return fund can still be very much hit and miss. The use of derivatives in this sector, though limited by Ucits rules, can also exacerbate bad investment decisions.
Kevin Pollard is senior research analyst at Thomson Reuters Lipper