Absolute return funds have been in the headlines in recent weeks, with the IMA’s overhaul of the sector looking to address some historic criticisms.
Many of those criticisms have focused on the idea that positive performance is ‘promised’, rather than simply targeted. As a result, he trade body has made the target element much clearer and the timescales to achieve returns more flexible.
A further criticism has concerned the wide array of funds included – with little but the performance goal in common, comparisons can be broadly useless. As things stand, the IMA also has this issue on its radar but said some sub groups would be too small to warrant their own sectors at this stage.
When analysing the peer group, the natural option is to split it into broad categories and identify the top performers in each, with equity, bond and multi-asset/global macro the major areas.
Even within equities, there are very different strategies at work, highlighted by a wide disparity of returns.
Top of the sub group over three years to mid-April is Odey UK Absolute Return, with its near-80% return among the best of any fund.
According to manager James Hanbury, the portfolio has maintained a long equity and short government bond stance, with outperformance largely coming from stock selection.
Long equity exposure is currently just over 145%, with the level rising since 2009.
‘Despite US politicians’ best efforts, the global economy is improving and most central bankers determined to get wage inflation back into the system,’ adds Hanbury.
‘This should be a good environment for equities on low multiples and we are finding plenty of attractive stocks.’
Favoured long positions include Sky Deutschland, Regus, Berkshire Hathaway and Sports Direct International while shorts include pharmaceuticals following its recent outperformance.
Hanbury said R&D productivity in the drug industry has been declining exponentially since 1950.
“This productivity problem has been counteracted for much of the past 60 years as growing global populations, increased access to healthcare and drug price inflation in the USA made new drugs much more profitable,” he added.
“If these trends continue, the earnings power and terminal values of most pharmaceutical companies will be drastically lower than current share prices imply.”
Next up in the equity sub-group – and second in the sector overall – is Cazenove Absolute UK Dynamic run by Paul Marriage and John Warren.
A lower-risk portfolio than Hanbury’s, the fund is up almost 33% over three years and 10% over 12 months, almost two-thirds less than the Odey fund in both instances.
Reasons for this performance gap are clear, with much lower gross exposure on the Cazenove vehicle.
Marriage and Warren had just less than 84% long and around 40% short at the end of February, against respective figures of 145% and 113% for Odey.
Looking at current conditions, Marriage said that while share prices have generally been rising, he is not hearing the same level of exuberance from management teams.
“Most companies we meet see little evidence of the tough operating conditions of 2012 abating,” he added.
“This is a cause for caution and valuations are becoming fairly extended, particularly in the FTSE 250. We are not overly exposed to these names on the long book and our short book is better placed.”
Marriage highlights another solid year for the strategy in 2012, with returns coming from a broad range and type of stocks.
“All sectors played their part, excluding resources, and long winners have come from both value and our P3M (product, market, margin, management) stocks in equal measure,” he added
“The fund has been resilient in down markets and risen gently in rising conditions, so we feel the short book has done the job when required.”
Moving to the multi-asset/global macro group, there are also several consistent outperformers to be found, with
Standard Life Investments’ massive Gars (Global Absolute Return Strategies) portfolio continuing to win assets.
In basic terms, GARS has three sources of return, market, directional and relative value calls.
’Market’ focuses on assets expected to provide long-term performance above cash – namely equities, corporate bonds and real estate – while directional bets are based around currency and interest rate views.
Finally, relative value calls have included financial versus broader corporate credit.
“We anticipate a variable and protracted recovery in global markets, which will offer profit opportunities in areas of higher growth, such as US and Chinese equities and larger-cap US technology companies,” the team said.
“Credit continues to provide a source of diversified and sustainable income, along with global real estate and high dividend-yielding European stocks. We are also seeking to exploit disparities in developing market – we believe the Indian rupee remains undervalued relative to the Singapore dollar for example.”
More recently, the team closed its UK versus European forward start duration position, as it became apparent the Bank of England was adopting a more tolerant inflation policy.
“This change in tone, with the focus shifting towards stimulating growth, will likely cause the UK yield curve to steepen, as long-term interest rate expectations rise,” they added.
“We had previously expected the yield curve to flatten.”
With the US currency strengthening in February, the fund also benefited from its dollar versus euro and Mexican government bond versus euro strategy.
As might be expected, returns from the absolute return bond grouping are generally lower, although three funds are up 10% or more over three years.
Threadneedle Credit Opportunities is the best of these, taking long and short positions across pan-European credit.
Manager Barrie Whitman said investment grade and high-yield markets performed strongly over 2012, with both supported by the ongoing search for yield.
“We continue to focus on our five core strategies – carry, event-driven, directional, relative value and basis trades,” he added.
“Over 2012, performance came from very strong total returns from high yield and investment grade as spreads narrowed. We adopted a more constructive approach on peripheral issuers as the year progressed, buying the likes of Banco Espirito, albeit remaining cautiously positioned on peripherals overall.”
Over the rest of the year, he is not expecting a repeat of 2012’s performance from investment grade or high yield.
“However, while it is difficult to see how yields can fall significantly further from current levels, spreads remain reasonably attractive and should continue to provide some support,” added Whitman.
“Moreover, demand dynamics within the high-yield space in particular remain strong.”