“A lot of absolute return funds came to the market in the past five years,” says Jeroen Vetter, a consultant on branding and business development based in the Netherlands and managing director of GUIA Advisory. “Some funds claim they will deliver positive returns in all market conditions, and that is almost impossible to claim. In recent years, in fact, a lot of absolute return funds have not done particularly well.”
Absolute return funds pledge to differentiate themselves from their more traditional relative performance peers by adopting strategies that may not achieve the best returns in bullish markets, but they should provide a much better likelihood of remaining in the black when things take a turn for the worse.
Appropriate benchmarks
So investors must adjust their expectations accordingly. Omar Gadsby, head of fixed income fund selection at Credit Suisse Private Banking and Wealth Management, says his personal benchmark for the absolute return funds he selects is mainly related to the preservation of the capital of clients.
“If a fund has a very clear objective to preserve capital over rolling 12-month periods, then it may fall in the absolute return category,” he says. Gadsby believes that, before the crisis, it was a common view that a fund would be meeting this goal by performing better than Libor. But with monetary policies by central banks turning so lax in the past few years, this is not enough any more.
“We want to deliver products that enable our clients to continue to achieve purchasing power adjusted for inflation. So in practice, my benchmark today is inflation plus Libor.”
This is not by any means an easy task for a fund to accomplish. For example, the L&G European Absolute Return Fund, launched in early 2010, aimed to give positive returns over 12 months using derivatives on the European stock markets. This was a bold promise that was not possible to keep
with all the turmoil that hit the eurozone. The fund lost up to 17% in a 12-month period and was liquidated in June 2013.
Words are easy
“Especially at the beginning, many absolute returns funds promised a lot,” Vetter says. “As a result, many funds overpromised and underdelivered. But what they must do is to underpromise and overdeliver.”
One example of the latter approach, he noted, is the Old Mutual Global Equity Absolute Return Fund, which has the objective of achieving capital appreciation while closely controlling risk. Its emphasis is on, above all, having a low correlation with equity and bond markets alike and, since its inception in July 2009, it has had an annualised performance of 7.8%, with 5.3% of volatility.
What’s in a name
Absolute return funds often employ strategies that are derived from hedge funds, with the limitations that Ucits products are exposed to. But the examples above show that having the tag ‘absolute return’ attached to a fund name does not necessarily mean the product will be up to the job.
Tristan Delaunay, CEO at Paris-based Athymis Gestion, holds the view that a traditional diversification approach is not enough to guarantee the success of an absolute return strategy. In fact, he says that such strategies, which strive to take advantage of the lack of correlation between asset classes such as equities and bonds, are destined to disappoint in a new market environment shaped by unconventional monetary policies.
“It is now possible to be wrong on both equities and bonds,” he says. “You can lose on the two of them at the same time, which was hardly the case before.” Therefore, he believes that an intelligent approach to alternative investments is the only way to achieve the performance that qualifies a fund as a purveyor of absolute returns.
“Absolute return funds have often been presented as the Holy Grail,” Vetter argues. “But deep knowledge is required to invest in them from a selection point of view. “They use a wide array of instruments. They use derivatives such asfuture, swaptions, CDs and CFDs. So in most cases they can use leverage, and they can take short positions – although synthetically.”
Only time will tell
The selection of the right absolute return funds is not made any easier by the fact that a large number of new products have been added to the market in recent years. Very often, they have not had enough time under their belts to ensure investors that they are able to meet the promised targets. Gadsby, for instance, works with a requirement of a proven three-year track record of good performance. In fact, he would rather have more – his ideal situation is to have a fund with a five-year history of work well done.
“But very few absolute return funds have three-year track records that are good,” he says. “And even fewer have such a record that goes back five years.” He also expects that the selected funds deliver absolute returns in a way that can be assessed regularly. His own time frame includes a twelve month review.
“I will review a fund for its contributions from credit, corporate bond selection, credit beta hedges and credit default swaps if they are being used to hedge corporate bonds,” he said. “I will want to see contributions from foreign currency, and also that it has been delivering on interest rates.”
What is real?
One of Gadsby’s main goals is to weed out what he calls “beta disguisers”, which are relative performance funds that present themselves as absolute return seekers but do not do enough to deserve the tag.
“There are funds in the absolute return group that are essentially long high yield bonds and cash,” he explains. “They are exposed to essentially two assets. If high yield spreads widen, they take a significant hit because they do not have assets to compensate for it. So they are basically funds that offer high yield beta disguised as absolute return funds.”
Selecting a new absolute return fund is a laborious task that must pay a close attention to risk management practices and investment strategies, among other things. “We never want Ucits funds that are highly leveraged,” Gadsby says. “We also try to avoid Ucits absolute return funds with hedge fund-like performance fees. This has increasingly been an issue for us.”
He also focuses on medium to large asset managers, rather than funds managed by boutique managers, which in his view tend to behave more like hedge funds.
Bad timing
An absolute return strategy requires enough sang froid from investors to stick with trusted funds even during times where their relative performance peers are doing well. For example, in the past two years, when equity funds benefited from the latest market in the US and, later, in Europe.
Vetter believes investors do not always fully benefit from absolute return funds as they tend to get out or get into them at the wrong times. “Many absolute return funds have been designed to appeal to investors who cannot afford big losses due to sudden market movements,” he suggests.
“And it is important to keep in mind that they are most likely to never do extremely well. They do not try to ‘beat the market’ on a relative basis, but aim to meet their objectives. “I know a small number of funds that look very boring at first sight but have consistently delivered 4% to 6% average annual returns over the past few years.”
