Three protective offerings for absolute return sector sceptics

While investors are often deterred by some of the IA Targeted Absolute Return sector's volatility spikes and lacklustre returns from some of its larger funds, there are still highly attractive diversification benefits and downside protection to be found within it, according to Chase de Vere's Ben Willis.

The head of portfolio management maintains what he describes as a "high weighting" to so-called alternatives across the firm's cautious and balanced portfolios, given how volatile both equities and fixed income investments have been recently. 

However, he warned that investors need to tread carefully to avoid opaque funds, those that have struggled during previous market downturns and those with too many complicated mechanisms - otherwise, reasons for underperformance or outperformance will
remain unknown.

"When we talk about our use of alternatives, we're talking multi-asset strategies or absolute return-type funds. But really, what we want from those is for them to be boring, consistent grinders that are not going to be volatile, and are not going to lose you money," Willis explained.

"Vehicles such as [Standard Life] GARS, or Invesco GTR [Global Targeted Returns], which we have held in the past, are great when they get it right. But when they get it wrong, the drawdowns can be quite severe.

"We get that from equities - we do not need that or want that from our alternatives."

As such, the head of portfolio management said he is choosing portfolios that are "really very boring", have a proven long-term track record during down markets and which are predominantly long-only, and therefore "not too complex".

"They are steady Eddies. If you have a high appetite for risk, these funds will not excite you. You would not even give them a second look. But if you want something to protect you on the downside, they are great investments."

Here, PA's sister title Investment Week shines a spotlight on Willis's three favoured "steady Eddies": Investec Diversified Income, BNY Mellon Global Dynamic Bond and Church House Tenax Absolute Return Strategies.

1. Investec Diversified Income

Made available to retail investors in March 2008, but having been offered to institutional investors since 1994, Willis said the £1.3bn Investec Diversified Income fund has an enviable track record.

"Investec is primarily an income-producing fund, which we therefore use in our income portfolios," he said. 

"The team - led by John Stopford - pays close attention to volatility and they have done a good job through several market cycles.

"We are confident they can continue that, all while giving a nice yield. And Stopford has a pedigree in fixed interest, so you can rely on him to make asset class calls and defend capital."

Over five years, the fund has returned 19.8% with two-thirds less annualised volatility than, simply as a point of comparison, the equity-only FTSE All-Share index, according to FE data. 

It also has a maximum drawdown, which measures the most money lost had investors bought and sold at the worst possible times, of 4% over the same time frame. It yields 4.2%.

2. BNY Mellon Global Dynamic Bond

The £2.2bn BNY Mellon Global Dynamic Bond fund, which adopts a team-based approach to management, was the most recent addition to Chase De Vere's discretionary managed portfolios.

"You could argue the team is not dissimilar from what the Investec team is trying to do, although it runs it on a total return basis so income is less of a focus," said Willis.

"The portfolio is run on a thematic basis and, while it is not focused on dividend yield pay-out, it does still offer a yield.

"Again, the fund has been up and running since 2004, so you have plenty of volatile periods of time over which you can check the performance and see that it has done what it was supposed to do.

"2008 was probably its worst year, but relative to other assets and other funds, it held up extremely well."

The fund, which holds a mixture of government bonds, investment-grade corporates, high yield and convertible bonds, also has a small weighting to derivatives for downside protection.

It has just one-sixth of the volatility of the FTSE All-Share over five years, a maximum drawdown of 2.2%, and a total return of 9.3%. It yields 2.1%.

3. Church House Tenax Absolute Return Strategies

With a much smaller AUM of £408m, Jeremy Wharton and James Mahon's Church House Tenax Absolute Return Strategies fund has been running since 2007.

"While the Newton fund invests in bonds, Church House can invest in equities as well and has a lot of flexibility in terms of asset class," Willis continued.

"If they like equities, for instance, they can start building positions in equities, but they are not going to be an equity fund - they're trying to protect client capital. They're very transparent with what they are holding in their portfolio."

For instance, one of the biggest asset class weightings in the fund is currently AAA-rated floating rate notes, at 44.2%.

Over five years, the fund has returned 15.06% with a maximum drawdown of 2.2%. 

It has been less than one-quarter as volatile as the FTSE All-Share index.

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