Fund buyers are increasing their exposure to absolute return equity funds to take advantage of sharp falls by companies which miss earnings estimates.
With stock markets having risen sharply last year to trade at, or near, record highs, managers are growing wary of valuations, especially as the penalties for disappointing earnings growth become ever more severe.
This month Rolls Royce, Tate & Lyle and BAE fell by 10% or more – Rolls Royce dropped 16% in a single day – following either a profit warning or disappointing earnings.
Last week, Royal Bank of Scotland also tumbled 8% on the day its full-year results were published, as traders dumped the stock following worse than expected numbers from some of its divisions.
Buyers are increasingly looking to equity managers with the ability to short stocks at risk of similar large falls, in order to protect investors’ portfolios.
Tony Lanning, manager of J.P. Morgan Asset Management’s Fusion multi-manager range, said the “brutal” way the market reacted to recent earnings misses marked a turning point for allocations.
“The environment is beginning to move to a stockpicking approach,” he said.
“We are beginning to see what happens when companies miss earnings – this is not the time to be buying the index.”
The manager is adding to his holding in the Melchior European Absolute Return fund in order to protect on the downside: “When markets are performing poorly, it is a good diversifier,” he said.
Time to switch
Bestinvest’s senior research analyst, Ben Seager-Scott, said his firm has also changed its strategy in terms of its equity exposure.
“The house view now is to take profit on equity and add into absolute return,” he said.
“Last year, you could do well from broad market movements, but now the benefits for beating earnings forecasts are becoming increasingly muted, whereas if companies miss estimates, their shares are punished a lot more.”
Long/short equity funds, such as BlackRock’s UK Absolute Alpha fund, experienced a surge in popularity during the crisis years, growing to multi-billion pound portfolios.
However, as the recovery gained ground, investors turned their attention elsewhere, and many products have been eclipsed by multi-asset absolute return vehicles like Standard Life Investments’ Global Absolute Return Strategies (GARS) fund.
“When GARS popped up, people were talking about the end of long/short funds, but it is not true,” Seager-Scott said. “For whatever reason, they have got a bit of a bad name.”
Rob Burdett, co-manager of the £1.5bn F&C Navigator range, agreed the environment is now once again favouring long/short portfolios.
“Recent share price multiple expansion has been driven by an expected future recovery in earnings, all based on the assumption economic growth will indeed continue to recover,” he said.
“Where that recovery does not come through – or is insufficient to support earnings growth – share prices look vulnerable.”
Burdett and co-manager Gary Potter hold a number of long/short funds across the range, including the Majedie Tortoise and Odey Odyssey funds.
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