Charles Stanley: Are absolute return funds any good?

Absolute return funds seek to make profits using investment techniques that differ from traditional funds. They may use short selling to bet on falling share prices, buy futures, options and other derivatives, as well as additional “unconventional” means. But are they any good?

The sector has been subject to a lot of scrutiny, as money continues to pour into these investments. This has led some to question whether absolute return funds are a fad, or whether they offer a genuine source of diversification. You have to be selective, patient and really know what you are buying.

Historically, investors have turned to assets such as government and corporate bonds to diversify their equity exposure, but increasingly they are venturing into absolute return funds that attempt to deliver positive, uncorrelated returns regardless of the underlying market conditions. However, some have accused these funds of being expensive and providing lacklustre – or even negative – returns.

Grouping funds into sectors can be a useful way of breaking down the vast universe into manageable chunks, but it can also lead to the false assumption that all funds in a particular sector are doing the same thing. Unfortunately, the reality isn’t quite so simple, and the eclectic mix in the sector underlines the importance of understanding the individual product, rather than having a vague sense that a fund is ‘defensive’ or ‘should hold up reasonably well in a down market’.

The reality is far more nuanced. Take, for example, Standard Life Global Absolute Return Strategies, widely known as ‘GARS’. This £25bn behemoth’s annual target is 5 per cent above cash before fees. The management team construct a diverse portfolio of investment ideas based on their macroeconomic views, which may include favouring one currency over another, or taking a view on whether large caps will outperform small-cap stocks in a particularly market. This collection of ideas is implemented in a variety of different ways and produces a spread of positions that complement each other and should produce uncorrelated returns.

Since its 2008 launch, GARS’ performance has captured investors’ attention, but a difficult 2016 broke the strategy’s aura of invincibility. For what it’s worth we still believe GARS is a strong option, but recognise Invesco Perpetual Global Targeted Returns, which is run in a very similar fashion having been set up by former members of the GARS team, as a strong alternative. The team make good use of the breadth of resource across the Invesco Group and its performance has been very encouraging since its 2013 launch.

Another option we favour, the Jupiter Absolute Return fund, has a very different method. It has no specific performance target versus cash, instead seeking to deliver a positive return independent of market conditions. We consider manager James Clunie a specialist in identifying overpriced stocks and shorting them, meaning the fund profits if the stock’s share price declines. The portfolio comprises various global stocks, combined with short positions and some small positions in diversifying assets such as gold. Often the fund has been negatively correlated to the MSCI World index and is an excellent potential diversifier.

We take the view that while a number of these funds’ returns can look sluggish when equity markets are soaring and they won’t necessarily produce the ‘absolute’ returns they advertise across shorter time horizons, their worth becomes apparent in equity market downturns and can offer a level of diversification that isn’t on offer from other asset classes. We believe holders of these funds should remain patient. After all, you wouldn’t cancel your fire insurance because you haven’t had a fire.

Ben Johnson is collectives analyst at Charles Stanley