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Absolute return funds show high equity correlation

Advisers are being warned to scratch beneath the surface of absolute return funds as data reveals they are highly correlated with the FTSE All Share.

Of the 57 funds in the IMA UK Targeted Absolute Return sector with three-year track records, 14 have correlations of more than 0.71 with the FTSE All Share over the three years to 30 June.

Many investors use absolute return funds to sidestep stock market volatility.

The £274.7m Threadneedle UK Absolute Alpha fund has a correlation of 0.89, according to FE Analytics.

A Threadneedle spokeswoman says many absolute return funds have benefited from the boost to asset prices from quantitative easing, but says any link with the market is temporary.

She says: “A main characteristic of absolute return funds is the aim to deliver positive returns irrespective of market conditions. Whilst capital protection cannot be guaranteed, the Threadneedle Absolute Alpha Fund’s ability to withstand market falls was demonstrated in 2011 when it returned + 3.8 per cent against a market decline of 3.5 per cent.”

The £426m Henderson UK Absolute Return fund is 0.83 correlated to the index, although co-manager Luke Newman says that is not a bad facet in times of strong equity market returns.

Newman says: “We vary the net exposure of the strategy between – 30 per cent net short and + 70 per cent net long depending on the opportunity set we see. There is not a fixed relationship [of correlation] with the index.” He adds over the 10-year life of the strategy, the correlation is 0.32 with a beta of 0.13.

Whitechurch head of research Ben Willis says: “It’s always been a mixed bag sector. There are a number of funds trying to achieve different things using different techniques so you’ve really got to do your homework and make sure you scratch beneath the surface.”

Willis says over the past few years, correlations between asset classes have been increasing, meaning many multi-asset absolute return funds will have higher correlations than usual.

He says: “Some of the market-neutral funds have found it quite difficult recently, and you tend to see that when volatility is quite low and also when markets are being influenced by the macro outlook, such as recent statements by Bank of England governor Mark Carney.”

Hart Greaves chartered financial planner Paul Greaves says absolute return funds make up between 4 and 6 per cent of his clients’ portfolios.

He says there tends to be defensive funds and aggressive, almost hedge-like funds in the sector along with what are effectively strategic bond funds.

He adds: “It’s important to know what you’re looking for and what you’re going to get.”

 
Correlation between absolute return funds and UK equities and bonds
Highest Correlation FTSE All Share Barclays Sterling Gilts
Threadneedle UK Absolute Alpha 0.89 -0.21
Henderson Absolute Return 0.83 -0.36
Church House Tenax Absolute Return Strategies 0.83 -0.24
Premier Liberation Absolute Growth 0.82 -0.29
 
Lowest Correlation FTSE All Share Barclays Sterling Gilts
City Financial Absolute Equity 0 0.14
Old Mutual Global Equity Absolute Return -0.01 0.01
Church House Tenax Absolute Return Strategies -0.02 0.05
Premier Liberation Absolute Growth -0.03 0.3
Shows correlation of Absolute Return Funds to UK equity and bond markets over three years to 30 June
Source: FE Analytics

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