21 February 2019
By John Husselbee, HC Verbatim Portfolio Growth co-fund manager
Beyond performance (which, as we all know, is impossible to guarantee), value for money and transparency would likely top the wish list for most when it comes to investing in funds.
For me, the onus is very much on the industry to get its house in order but where it fails to do, regulators have shown themselves willing to step in. One manifestation of this is the Financial Conduct Authority’s (FCA) recent asset management survey and among many areas singled out were absolute return funds and how groups offering these market them to clients.
Absolute return vehicles – particularly the global macro offerings – have arguably been the dominant trend in investment markets in recent years, with some growing to tens of billions in assets. Demand for absolute return and ‘liquid alternative’ products has ballooned and there are now well over 100 funds in the IA’s Targeted Absolute Return sector plus a number of others dotted around the Global, Specialist and Unclassified peer groups.
Without naming names, recent unspectacular returns from many of these vehicles and heavy outflows show the gloss is very much off them.
Over three years to the end of 2018, the average Targeted Absolute Return fund produced a return of 3%. While indisputably a positive absolute return, this has been dragged up by several funds registering double-digit performance and also looks pretty anaemic against a 12%-plus average from UK equity funds and 34% from global bond vehicles over the same period.
Advocates would argue such comparisons are pointless and many absolute return funds have met their objectives but this is a tough case to make given the number of portfolios losing client capital in what has been a fairly benign market environment, at least until the last few months.
While we are never keen to focus too much on one-year numbers, performance of these portfolios over the last 12 months is concerning, with an average loss of 3%. Of course, conditions have been much tougher, but if investors are assuming positive performance against all backgrounds, they will be sorely disappointed.
For me, many of the industry’s current talking points coalesce in the debate around these funds – from concerns over poor value for money and lack of transparency to the growing realisation that one size rarely fits all when it comes to investment.
The sheer dispersion of returns shows this is not a sector that can be assessed in broad terms and any discussion of an ‘alternatives’ peer group is largely pointless. Constituents have varying performance objectives and benchmarks and many even invest in different asset classes: the only overriding aim for the sector is to produce a positive return over three years.
With such a range of strategies in the alternatives space, it stands to reason that the risk profiles on offer can differ widely and investors flocking to the sector as a perceived safe haven may come away disappointed – and this reinforces the point about one size rarely fitting all. Anyone putting a large part of their portfolios into these strategies – nominally as a low-risk way of eking out positive returns year after year – potentially needs to reassess their investments, from a diversification standpoint if nothing else.
On the transparency question, I have never felt investors need to understand every lever and pulley in a fund to be an informed buyer but many global macro products are effectively black boxes, combining tens or even hundreds of strategies in search of returns. To some extent, to quote Tiger Woods, winning takes care of everything, and while these funds were posting strong performance, few investors were too worried about looking under the proverbial bonnet.
Now several have actually lost money, investors are understandably asking what they have bought into and this lack of transparency is a major issue given the FCA’s critical review of the asset management industry.
Saying that, we do continue to see a role from absolute return funds in a portfolio but only as one element: very much a component of a solution rather than the solution itself. We have long been bearish on fixed income and while bond have a part to play, we have long been underweight the asset class and have balanced out some of this position using alternative funds. In fact, our absolute return and bond exposure helped offset weakness from our equity holdings to a small extent in the fourth quarter in 2018, showing the benefits of diversification in action.
For our part, we see alternative products as providing low correlation to traditional asset classes and divide potential holdings into hedge funds (or return enhancers) and absolute return vehicles (risk reducers). Both play important – but very different roles – in our portfolios, again highlighting that ‘alternatives’ come in all shapes and sizes.
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