Rebecca Jones asks three investment managers whether absolute return strategies deliver on their promise.
Ben Gutteridge, Head of fund research, Brewin Dolphin
It was exactly a year ago we first highlighted our concerns that the ‘average’ IMA targeted absolute return fund was of little benefit to the ‘average’ equity biased portfolio. A year on, nothing has changed.
Given the persistent and high levels of correlation with the FTSE All-Share, it appears the typical absolute return fund manager is merely assuming a modest amount of equity risk, while leaving the vast majority of assets in cash.
The net result for the client is simply a lower risk - and lower return - iteration of equity market performance. The sector, on average, therefore, is a poor diversifier of risk assets and should be treated with trepidation in regard to the role it actually fulfils within portfolios. This is particularly the case given funds of this nature typically levy a rather odious performance fee.
Are absolute return funds a waste of money?
If we take our analysis further, to incorporate modern portfolio theory, the case for inclusion of absolute funds is even further undermined.
If the proposed formula is ‘additional asset sharp ratio > current portfolio sharp ratio x correlation of additional asset and portfolio’ then the additional asset will increase the efficiency of the portfolio.
In this specific regard, the additional asset (IMA Targeted Absolute Return sector) sharp ratio is 0.64, the current portfolio (FTSE APCIMS Balanced) sharp ratio is 0.92 and the correlation is 0.8. Following this through, the additional sharp (0.64) is less than portfolio sharp x correlation (0.736).
So, modern portfolio theory informs us that adding the average absolute return fund to a typical balanced portfolio decreases the efficiency of that portfolio rather than enhancing it.
Chris Mayo, Investment director, Wells Capital Investment Solutions
Absolute return funds aim to achieve a positive return throughout market cycles, irrespective of movements in equity and bond markets. To achieve this, funds must employ strategies that ensure its return is not closely correlated with the performance of any risk asset.
In a multi-asset portfolio, the allocation of holdings across a range of assets and geographies should, in normal market conditions, allow it to continue to make an overall positive return over the market cycle for each asset class.
For a portfolio invested in a single asset class, or significantly allocated to one class, the benefit of diversification is reduced. In such a portfolio, the use of absolute return funds should improve the steadiness of return throughout the market cycle.
In strong bull markets, the lack of correlation to the asset class is likely to see the inclusion of absolute return funds reduce portfolio performance in price terms. However, when risk-related performance is measured, the reduced volatility provided by absolute return funds should improve the performance of the portfolio relative to its peers.
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