The dire performance of absolute return funds in 2016 has lent a lot of weight to the saying, ‘If it sounds too good to be true, it probably is’.

These funds aim to deliver positive returns in any market condition. Even if the stock market has plummeted, the funds should keep on growing – or at the very least record a flat performance after fees. They’re designed to add a degree of capital protection to your portfolio.

Unfortunately, several well-known absolute return funds didn’t succeed in their aims last year and suffered huge losses.

Financial advice firm Chase de Vere has analysed 3,071 investment funds and found three of the bottom four performers belonged to the targeted absolute return sector in 2016. FP Argonaut Absolute Return (GB00B7FT1K78) lost 25.6%, CF Odey Absolute Return (GB00B55NGR79) lost 17.8% and Old Mutual UK Opportunities (GB00BBQ2T214) lost 11.6%.

Excessive risk

Patrick Connolly, head of communications at Chase de Vere, says some absolute return funds are taking on too much risk and exposing investors to ‘major and unexpected losses’.

‘It is astonishing that funds which supposedly aim to provide a positive absolute return can lose so much. This is not what investors in this sector would expect and the performance of these funds is doing absolutely no favours to the sector as a whole or to the investment industry in general,’ he says.

Connolly has called for funds taking on excessive risk to be removed from the absolute return sector and reclassified elsewhere.

A spokesperson for the Investment Association (IA), which is responsible for categorising funds, says absolute return funds are not guaranteed to produce positive returns in any market condition.

In the absence of a name or sector change, investors have to make do with the association’s monitoring tool, which shows how many times a fund has achieved or failed to deliver returns greater than zero after charges over 12 months.

High fees

Several financial advisers think investors should stay firmly away from the sector. Peter Chadborn, director at Plan Money, says he has never felt comfortable with the promises made by such funds and therefore does not recommend them.

‘We believe there are more effective methods of controlling risk, not least because absolute return funds can be very expensive,’ he adds. For example, CF Odey Absolute Return has an ongoing charge of 1.4%.

Mike Gordon, technical director at Rutherford Wilkinson, suggests investors would be better off diversifying at a portfolio level and investing over the longer term to reduce risk, rather than relying on outcome-oriented funds.

‘These returns still rely on the manager making the right calls, which has obviously not happened with some of these funds, highlighting the risks managers have taken on,’
he adds.

Joshua Gerstler, financial adviser and company director at The Orchard Practice, says his firm sometimes use absolute return funds in its portfolios, but it limits exposure to between 5% and 10%.

An absolute return fund on The Orchard Practice’s recommended list is Newton Real Return (GB00B7VVXF60), which grew 4.03% in the year to 31 December 2016 compared to the sector average of 1.06%.

Portfolio diversifier

Ryan Hughes, head of fund selection at AJ Bell, believes absolute return funds do still have an important role to play. He says they offer excellent diversification in a portfolio, which could be particularly useful in the current environment in which fixed interest investments are likely to deliver negative real returns when taking into account inflation.

‘There is a wide range of investment strategies to select from, some of which are likely to be appropriate for lower risk investors as a way of looking for returns in excess of cash.

‘The last year has shown the need for careful analysis and selection – just because the words “absolute return” are in the name, doesn’t mean these investments can’t lose money,” Hughes adds.

If you’re considering investing in an absolute return fund, take a good look at the underlying investment strategy. Hughes says that because FP Argonaut Absolute Return increased by nearly 40% in 2013, investors should realistically expect it will fall by the same amount in another year.

‘There is no such thing as a free lunch and it is important to remember that in order to generate returns above the amount you can get in the bank on cash, you must take risk,’ he explains. (EP)

What do the fund managers have to say?

OLD MUTUAL UK OPPORTUNITIES 

‘The fund follows a market-directional strategy, and has been clearly marketed as such. In other words, unlike many of the funds in the IA Targeted Absolute Return Sector, it is by its very nature designed to express a view on the prospects for the market as a whole, whether that view is positive or negative.

‘The fund’s clearly stated objective is to “deliver an absolute return over rolling three year periods”. As such, the fund’s aim is to generate a positive absolute return across the market cycle, rather than in any individual rolling 12-month period. Given the difficulty of timing markets, the fund’s directional views can lead
to meaningful capital drawdowns at times.

‘We believe there are important differences between expressing a view on the potential direction of the stock market within a market-directional fund, and taking on “excessive investment risk”. Individual positions within the
fund were, and remain, proportionate, with no single
view making an outsized negative or positive contribution to performance in 2016.’

FP ARGONAUT ABSOLUTE RETURN

‘The performance in 2016 was very disappointing, but put in perspective it is the first year in seven since launch where the fund has not made a positive return. It has also been a year in which most long/short European managers often with differing strategies and market views have struggled. The fund’s long term track record is still amongst the best in the sector.’

CF ODEY ABSOLUTE RETURN

Declined to comment.

‹ Previous2017-01-26Next ›