Church House’s Liddle: Absolute return criticism ‘not without merit’


The targeted absolute return sector has been the subject of considerable criticism of late. Charges of poor performance, high fees and low transparency have all been levelled at the sector. To what extent is this criticism deserved?

We declare a vested interest (the Church House Tenax Absolute Return Strategies fund sits in the sector) but while we do not believe that all the criticism is warranted, some is not without merit.

Performance issues

Most people buy an absolute return fund to protect their capital when market volatility is at its most extreme. In what has been a difficult year for many fund managers, 50% of AR funds have delivered a negative return, thus failing to meet the requirement to protect against volatility. That leaves a lot of funds with a negative return and there have been some significant losses, with three funds in the sector seeing losses of more than 10%.

Some funds are also failing to deliver the ‘alpha’ they’d hoped to. Many absolute return funds suggest that they can use their stock or bond picking skill to harness market alpha, rather than being a slave to beta. Yet only around half the funds in the sector show a positive alpha score. This is disappointing and many investors might feel that absolute return funds have not delivered as promised.

There are, of course, poor funds in every sector but the difference with absolute return is that the concept itself is on the line. Some fund selectors have started to question whether it is possible to deliver a positive return over discrete 12-month periods with low volatility. They suggest that some volatility is necessary to deliver a return higher than cash. Clearly some of the fund managers don’t entirely believe this either as we’ve seen a number of funds shifting their time horizons from rolling 12-month periods to rolling 3-year periods.

A part of the problem is the confusion over what absolute return really means; funds in the IA Targeted Absolute Return sector has a bewildering variety of investment styles and objectives.

For the record, our definition of the absolute return objective is the delivery of positive returns in excess of cash plus fees over rolling twelve-month periods. We view an objective of cash plus 3% or plus 5% over longer periods as ‘targeted return’ for which a higher level of risk is required than for absolute return.

Misfortunes of the few?

We would add a number of things here; Firstly, we would take issue with the idea that the concept is somehow flawed. We believe that, done well, absolute return investing is far more in tune with the way most people want to invest. They want consistent, predictable returns, compounded over time, where the capital value is not subject to large drawdowns. In particular, it chimes with the new pensions’ landscape that will see far fewer people annuitise, and many hold risk assets long into retirement.

Equally, it could be argued that the perception of the sector, as a whole, might have been influenced, in part, by the short term performance of the larger funds which seem to have become a bellwether for the health of the sector as a whole.

We know it is possible to achieve these low volatility, consistent returns because a number of funds in the sector have done it. Our fund has had only three negative rolling 12 month return periods (out of 24) and we are not alone.

However, there are a number of important considerations when managing an absolute return fund. We believe in simplicity; derivatives add costs, leave the sector open to charges of poor transparency and while we recognise that they will have a place in some absolute return strategies, they need to be used with skill and discernment and a full appreciation of the risks involved.

Risky business?

Absolute return also means ensuring that every investment is made with an awareness of the downside risk. If we are targeting a positive return over rolling 12-month periods, we must invest on that basis. We believe that every individual investment beyond cash should offer a compelling reward potential, for an appropriate level of risk. If it doesn’t, we will hold cash.

While the risk of permanent loss of capital is the greatest concern of investors, short-term volatility is also important. An investor who can tolerate volatility, might simply invest in a long-only equity fund rather than an absolute return fund.

The absolute return sector has had some headwinds. Quantitative easing has distorted asset pricing and in particular has changed the pricing of risk. However, we make no excuses and believe that we have to operate in the environment in which we find ourselves. Nevertheless, we believe absolute return is an achievable – and worthy – target and the short-term problems of some funds in the sector should not distract investors from its merits.

The original concept behind absolute return was to address the simple hopes and aspirations of investors who didn’t want to lose their money. Yes, the economic environment has suffered a few setbacks, to say the least, and whilst it may have become more difficult to achieve this objective, it doesn’t change an investor’s goals so we should still run money on that basis.

Perhaps our fund managers have a certain advantage having traditionally run money for private clients. It means we have always had a direct connection with our investors and have always managed our fund in line with their goals. Running clients’ money with a sense that they’re looking over your shoulder provides excellent lucidity!

*All data: Financial Express to 16 September

Sam Liddle is sales director at Church House Investment Management.