Absolute return funds are well worth holding

The Absolute Return sector was something of a mixed bag in 2010.

Mark Dampier
Mark Dampier

The aim of these funds is to preserve capital and to provide steady incremental gains, averaging between around 5-10% a year, regardless of the direction of the stockmarket.

We have seen a rampant market over the last couple of years and the modest returns made by absolute return funds have appeared pedestrian by comparison. To compound the problem, some funds’ strategies have simply not performed, so I am not surprised some investors feel disappointed.

Despite this, I still feel absolute funds have an important place in investors’ portfolios. On two occasions in the last decade, the FTSE 100 fell by nearly half and it is during these turbulent periods when absolute return funds can really come into their own, particularly for those running retirement Sipp or drawdown. The importance of preserving and growing capital in such an environment can help offset the inevitable falls in other assets, helping you emerge from the downturn in reasonable shape.

“I still feel absolute funds have an important place in investors’ portfolios”

Although absolute return funds are lumped together in one sector, in reality they represent a variety of different styles and strategies. No one fund has all the answers in all environments, so it makes sense to build a portfolio of absolute return funds that complement each other.

In general, there are two main types – those that sell short and those that do not and a combination of these should give you reasonable diversification. In the latter camp, Newton Real Return and Troy Trojan – actually in the Balanced Managed sector, which shows you really need to look under the bonnet of these funds – are well worth considering. In the former, I remain a fan of Tim Russell’s Cazenove UK Absolute Target and Jupiter UK Absolute Return run by Philip Gibbs, despite their recent lacklustre returns.

Philip Gibbs probably experienced the worst performance of his career in 2010. The main issue was that he was far too defensive, plus his foreign currency strategies failed to pay off as sterling was relatively strong. However, to write him off based on a single year is ridiculous, given his fine record since 1997. (article continues below)

I am reminded of the much celebrated Anthony Bolton, who had many a year in the wilderness, particularly in the 1990s, before going on to excel. I recall defending Anthony Bolton on a number of occasions, much like I have been doing with Philip Gibbs of late. I agree with Gibbs that the global economic outlook remains highly uncertain and will probably do so for a number of years. Sovereign debt, inflation and a Chinese economic slowdown are all potential hazards. Having this fund, which can adapt to changing circumstances, in your portfolio could be a real help.

The recent risk-on, risk-off market volatility has caused problems for many funds that use shorting and it has been a particularly difficult time for Tim Russell, whose portfolio, broadly speaking, is long defensives and short commodities. For the last 18 months, there has been a distinct lack of diversification within equities. When risk is on, commodities drive the market higher and defensives lag. When risk is off, all equities, including defensives, fall. The fund has struggled as a result. Yet I feel that with so many portfolios having a high correlation with emerging markets and commodities, holding this fund could pay off at some point. The trouble is I don’t know when but I retain it in my own portfolio as an insurance policy against a commodities’ sell-off.

Despite the subject of this column, I remain quite upbeat regarding stockmarket returns in 2011 and in a continuing bull market, absolute return funds will clearly underperform. However, it would be a mistake to ignore the sector and these funds should help your portfolio through difficult times. True, you need a degree of patience to hold them but one day you will be glad you did.

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Mark Dampier is head of research at Hargreaves Lansdown.