As targeted absolute return funds look about to enter the last chance saloon, this could be when the best of these funds come into their own, says Darius McDermott, managing director, FundCalibre
Pensive is the word that comes to mind when I want to describe how I felt about financial markets as we entered 2022. Having seen a strong recovery from the Covid sell-off, markets looked expensive again and had numerous threats on the horizon.
January was dominated by concerns over interest rates and inflation, while February and March took a sinister turn from a humanitarian perspective, as Russia invaded the Ukraine. The result is a real unnerving of financial markets. At the time of writing, volatility, as measured by the VIX Index, has been extreme in recent weeks. But in reality, it has been more pronounced for the past couple of years*.
I’ve said for a while that a steady return of 4-6 per cent may not be such a bad thing in 2022. The question is, where am I most likely to get that return? Which brings me to the most maligned investment sector.
The past decade has been a story of feast and famine for the Targeted Absolute Return sector. These funds were “the place to be” for investors on the back of the credit crunch, as we all looked for steadier return profiles from our investments. However, a decade on from promises of steadier returns, many of these funds simply failed to deliver when it mattered.
Targeted absolute return funds are always under the microscope in times of stress. Take the Covid sell-off for example. The average absolute return fund fell around 7 per cent, compared to more than 25 per cent for global equities – that’s reasonable in the context of what was happening to global markets at that point**.
But it is the dispersion of returns in the sector, which often causes the biggest concerns. Take the past 12 months, for example. The difference between the best and worst performer is almost 50 per cent, with one fund returning almost 40 per cent in that timeframe***. I’m not sure that is the type of performance investors would expect from a targeted absolute return fund, as it has to be taking risks to get that type of performance.
I’ve talked before about the different types of vehicles in the sector – long-only, long-short, UK centric, global and fixed interest funds just some of the beasts sitting there. It makes no sense at all. This, coupled with significant performance failings, has seen investors pull huge assets from the sector in the past few years.
There are a couple of things I would like to say to defend the challenges faced by the sector. The first is the Investment Association launched a tool specifically for the Targeted Absolute Return sector, which allows users to look at performance over various timeframes – for example monitoring funds across benchmarks, risk ratings and sectors.
The second is that QE has made it harder for companies to fail as borrowing costs have fallen through the floor and has helped lift many equity markets. This means those managers looking to short losers and buy winners, have been fighting against a rising tide.
But there are good products in this sector – many of which do exactly what they say they will do in a simple, straightforward manner and can deliver that 4-6 per cent return I mentioned earlier. You just can’t compare apples with oranges (in this case ultra-defensive funds versus some which are basically hedge funds). So it’s all about understanding the risk/reward of each offering.
In summary, don’t dismiss this sector based on reputation – there are hidden gems which could offer the perfect solution to a lot of the problems facing markets in the next 12 months or so.
Funds to consider
SVS Church House Tenax Absolute Return Strategies – a defensive offering which has a blend of asset classes and is currently well protected from an inflationary environment with a considerable weight to floating rate notes. It has produced positive returns in nine of the past 10 calendar years.
LF Ruffer Diversified Return – although a relatively new fund, it is an extension of the wider Ruffer Investment Strategy, which has produced exceptional returns. The fund aims not to lose any money on any 12-month rolling basis, with a strong emphasis on providing genuine protection in times of market stress by investing across equities, bonds, derivatives and currencies.
TwentyFour Absolute Return Credit – invests predominantly in investment grade bonds that are due to mature shortly. It has been designed to be easy to understand and does not ‘short’ stocks or borrow any money to boost returns.
Janus Henderson Absolute Return – aims to deliver a positive absolute return over rolling 12-month periods. The managers look to identify stocks that will either exceed or fall short of analysts’ expectations and construct a portfolio of both long and short positions.
*Source: Google Finance, five years to 3 March 2022
**Source: FE fundinfo, total returns in sterling, 12 February 2020 to 16 March 2020
***Source: FE fundinfo, total returns in sterling, 3 March 2021 to 3 March 2022
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Darius’s views are his own and do not constitute financial advice.
This article was first published in the April 2022 issue of Professional Paraplanner.
