There is no doubting the current popularity of funds within the IA Targeted Absolute Return sector. Today there sits around £53 billion overall in the sector in the U.K., with some £450 million of estimated net inflows for September alone. Year-to-date flows into the entire sector have totalled over £8 billion and there are now ten funds with assets in excess of £1 billion (as at end of September 2015). The growth in the sector has been commensurately reflected in product launches. In 2000 the lone standard bearer was Newton Real Return which was joined in 2004 by a small trickle of funds. Since 2014, there have been 16 new funds launched into the sector which now comprises of 75 funds overall.
What exactly is an absolute return fund? Absolute return funds generally seek to generate a specified return over a given period. This can be an amount over a rate of interest such as Libor or inflation metric. Often the given period is stated as three years but can be vaguer: “market cycle” or another loosely defined rolling period.
Industry sector classification schemes allow investors to compare like with like for many investments, but absolute return can be harder to aggregate. The UK Investment Association (IA) for example, has seven qualifications to the definition of its Targeted Absolute Return Fund sector and includes a rolling 12-month monitoring analysis “on the expectation there is a wide expectation among consumers and advisers that funds in the Targeted Absolute Return sector will aim to produce positive returns after twelve months.”
Table 1. Five-Year Performance of IA Targeted Absolute Return Sector v U.K. RPI+3% and IA U.K. All Companies (to September 30, 2015 in GBP)
Source: Lipper for Investment Management.
The IA is correct to include so many qualifications and indeed the 12-month “expectation” is probably a reasonable assumption in reflecting investors’ perceptions and a prudent backstop. The name “absolute return” although perhaps not intentionally misleading, could lead unwary investors into a false sense of security. The reality is that many of the funds in this classification are in fact market-linked and although may contain structures to reduce volatility may not entirely eliminate it in the event of a substantial market move. And the IA since introducing the “targeted” component in 2013 is clearly tried to move away from the perception that these funds may be guaranteed.
Investors who have suffered through the volatility of 2015 and the recent “Black Monday” correction may be attracted to the concept of an absolute return. However, the lack of homogeneity in this sector is evident. Overall, it is populated with corporate bond funds, equity long/short funds, equity long funds with index short strategies, diversified multi-asset funds and multi-asset long-only funds to name a few. Indeed, the IA Targeted Absolute Return classification contains funds from over 20 of the more specifically defined Lipper Global Classifications. This makes true like-for-like comparisons much more difficult than many other sectors.
The varying nature of the composition of the sector is further revealed in the returns. The best performing fund year-to-date, City Financial Absolute Equity A Acc has returned 26.9% to September 30, 2015 while the worst performing fund over the same period, Henderson Credit Alpha Y Gross Acc Hdg has returned -5.7%. Over this period, more than 30% of all the funds in the Targeted Absolute Return sector have returned a negative amount.
Table 2. Best and Worst Performing Funds in IA Targeted Absolute Return Sector Year to date September 30, 2015
Source: Lipper for Investment Management.
For the longer-term, absolute figures appear better: over three years to September 30, 2015, only two funds in the sector have returned a negative amount and over five years to the same date, only a single fund has returned a negative amount. However, this doesn’t mean investors have benefited from stellar comparative performance. Over the three years to September 30, 2015, only 15% of absolute return funds have beaten a U.K. RPI +3% benchmark. Over five years, this increases to 21% (although there are fewer funds with a five year track record).
Looking at the sector for those funds which have a three year track record, Table 3 highlights some of the more consistent performers. Only 14 funds overall for the three year period were able to average a Sharpe Ratio Metric (as defined in the table) and the top ten are listed here.
Table 3. Top ranked performers in the IA TAR sector over 3 years
It is encouraging to see a good mix of differing types of funds in this list which indicate that consistent returns can be generated by good managers across a range of asset classes and styles but clearly investors need to understand thoroughly what strategy their absolute return fund is using. Many funds are esoteric with somewhat vague objectives and the sector is far from homogeneous.
Investors, who are sold on the concept of positive returns in all markets, may not actually get this and although many funds in this classification do exhibit lower volatility than other market linked funds, the opportunity cost as evident in Table 1. might be higher than one would expect.