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Safe option fails to deliver

The poor performance of absolute return funds may be due to their lack of risk-taking, reports Joanne Ellul

Absolute return funds were hit with their biggest outflows for three years during August and few are delivering positive returns, leading many to question what managers are doing about the poor performance.

The Investment Management Association’s August figures show the absolute return UK sector saw net retail outflows of £122m in August. This is the biggest outflow since the sector was formed in April 2008 and compares with an average monthly inflow of £162m for the past year.

Only 17 out of the 62 funds in the absolute return sector delivered positive returns over the three months fromthe end of June to the end of September, according to Lipper.

In July, Standard & Poor’s Fund Services warned that few absolute return funds have achieved their target in every year since launch and, in August, Fitch Ratings said some European absolute return and multi-asset flexible funds failed their “clearest test since the Lehman fallout”.

Odey Asset Management’s £198m UK absolute return fund is downby 11.16 per cent over three months to September 30 but up by 14.8 per cent over the year to the end of September, according to Morningstar.

Portfolio manager James Hanbury says the fund’s performance was hit in August by the two biggest holdings in the long book de-rating – Regus and Sky Deutschland. He says: “We are pleased with how things are progressing and we have topped up those two holdings. We have not had any profit warnings in our long book this year, but in the last few months there has been a significant de-rating.”

Hanbury says he has reduced the growth exposure of the portfolio, a step he believes is important during volatile market periods.

He has increased the fund’s exposure to convertible bonds, which offer investors the potential upside of conversion into equity, while protecting downside with cas flow from the coupon payments.

Hanbury says: “We have increased our exposure to Lloyds convertibles, which give a 14 per cent yield to redemption and a 10 per cent running yield and we think the risk return on those is extremely attractive. We are now close to 10 per cent in those, up from 7 per cent in June.”

Scottish Widows Investment Partnership’s £78m Swip absolute return bond fund is down by 1.9 per cent over a three-month basis and has a zero return on a 12-month basis to September 30, according to Morningstar.

Investment manager Juan Valenzuela says August and September have been tough months because the fund’s exposure on financials and some of the high-yield names has caused performance to weaken.

He adds that despite being defensive in the summer, the fund has suffered from the repricing of risk. Valenzuela increased the fund’s hedge position on the credit default swap indices, Itraxx Crossover and Itraxx Euro, to 7 per cent in mid-September, then cut it back to zero this month.

A credit default swap index is a credit derivative used to hedge credit risk or to take a position on a basket of credit entities.

Valenzuela says: “We have cut the hedge position to zero and increased risk marginally. We think that adding risk to the fund makes sense given the attractiveness of valuations. The liquidity on indices is better than the underlying cash bonds.”

Valenzuela says by buying protection on indices, the fund gives up a decent amount of carry and potential capital appreciation on assets. He says: “We envisage our allocation to high yield increasing in the coming months and expect to buy some credit paper in financials and industrials, which will increase our risk.”

Standard Life Investments head of multi-asset fund management Guy Stern is part of the team that runs the £8.4bn global absolute return strategies fund. The fund is up by 0.9 per cent over three months but down by 1.96 per cent over the year to September 30, according to Morningstar.

Stern says: “We have virtually a zero return for the year. I am disappointed we are below target, but as I look at the structure of the fund, in terms of the overall performance in the volatility of the fund and how it is reacting to news items in the marketplace, it is still very stable.”

Despite the fund’s poor performance, Stern says he has no plans to change the portfolio’s strategy.

He says he is buying options to access equity markets rather than buying equities on the cash market, adding: “Buying options means you have exposure to the equity market and exposure to the volatility. As volatility climbs, you have a way to mitigate the negative returns of equity markets.”

In contrast, the £35.1m Liontrust European absolute return fund is up by 4.3 per cent over three months and up by 9.7 per cent over the year to September 30, according to Morningstar.

Manager James Inglis-Jones says the fund has performed well in recent months due to a combination of two factors. He says: “The interim results season was, on average, positive for the fund. We had a number of long positions that reported better than expected interim results and a number of short positions that issued profits warnings.”

Thames River multi-manager Robert Burdett says the firm’s multi-manager range is light on absolute return funds because he would rather take a little bit more risk.

He says: “We are more pro equities versus absolute return. Having said that, we will be supporting the new Odey absolute return global bond fund.”


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