Absolutely (un)fabulous or an alternative to cash?
In a high risk low return environment absolute return funds may appear to be the Holy Grail; what many investors are looking for is an alternative to bonds and cash, to give a steady return, without the ups and downs of the stockmarket (ie. low volatility). This is what absolute return funds aimed at the retail investor are supposed to do; achieve a positive return, no matter what is happening in investment markets. However, under the headline, ‘An absolute waste of time?’, the FT reported at the weekend: ‘According to data from Morningstar, two-thirds of UK-domiciled absolute return funds have posted negative returns in 2016, despite being on course to register a record year of net inflows.’ Hardly doing what is says on the tin then!
Tricky to understand, charging high fees and promise the impossible?
So again said the FT. Is this fair? We look at two funds – the big daddy retail fund – Standard Life Global Absolute Return Strategies Fund (GARS), which has assets of £26.6bn and a quoted closed end (or investment trust), Ruffer Investment Company (£325m in assets).
What are the objectives?
The SL GARS fund aims to provide positive investment returns in all market conditions over the medium to long term. The fund is actively managed, with a wide investment remit to target a level of return over rolling three-year periods equivalent to cash plus five percent a year, gross of fees. The Ruffer fund has a simpler objective: ‘The principal objective of the Company is to achieve a positive total annual return, after all expenses, of at least twice the Bank of England Bank Rate by investing predominantly in internationally listed or quoted equities or equity related securities (including convertibles) or bonds which are issued by corporate issuers, supranationals or government organisations.’
In simple terms, while both funds are seeking roughly the same objective – to achieve positive returns above cash in all market conditions – the approaches are somewhat different. The GARS fund is a pretty sophisticated hedge fund which can use just about any investment instrument (currencies/derivatives/going short etc.) to achieve its objective; it also has a tougher benchmark (although this is set over a three year period) of targeting cash plus 5% per annum, whilst the Ruffer fund on an annual basis seeks just double bank rate (at least it is tougher when base rates are just 0.25%). Although the Ruffer fund can use different instruments as with the GARS fund, it is more in the nature of an asset allocation fund: in other words when the managers like equities it will have a reasonably high exposure to equity risk; when they don’t, it will seek the majority of its exposure elsewhere.
Tricky to understand?
Well, certainly in the case of GARS. Its factsheet sets out a quarterly portfolio risk and return analysis, very much in hedge fund speak. The headings are Market Return Strategies (this is straightforward investing in different asset classes), Directional Strategies (this is a kind of momentum investing, including such exotics as ‘US Real v. Nominal Steepener’ and ‘Long European Payer Swaptions’) and Relative Value Strategies (more in the nature of arbitrage between assets where there should be some linkage between the price).
The Ruffer fund is a lot easier to understand; its basic allocation at 31.08.16 was: UK and international index linked government bonds 44%, equities 37%, gold 7%, and other 12%.
But surely the point is that a hedge fund should be quite hard to understand; otherwise it would be simple to do it oneself.
Charging high fees?
If you invest in GARs through one of the online trading platforms, your total charges should be 0.9% a year (before dealing costs); there is no performance fee, unlike many hedge funds. The Ruffer fund seems slightly more expensive at 1.18% a year. But neither these are off the scale compared to the infamous ‘2+20’, where hedge fund managers charged a 2% management fee and took 20% of profits over the benchmark return (in performance fees).
Promising the impossible?
Well the proof is really in the pudding. What has the performance been?
Total Return Five Years to 30.06.16
So up until recently the GARS fund was more consistent – the Ruffer fund appears to be slightly more correlated with equities, perhaps as one would expect – but both have had a poor year to 30.06.16, particularly GARS. To be fair this was an exceptionally difficult period for investment managers generally, encompassing as it did some significant market moves; the China induced sell off in August 2015, the US interest rate scares, the bounce back in the spring and culminating in Brexit at the end of June. But this is when strategies should show their metal! What has gone wrong?
In a nutshell, as far as GARS is concerned they were expecting US interest rates to rise earlier and they were caught out in various equity bounces; with Ruffer it seems more to have been a relatively high exposure to Japanese equities.
Absolute return funds are never going to be a completely satisfactory substitute for cash; and fund managers will inevitably get some things wrong – if only timing. Nonetheless, as a diversifier from equities, in place of overvalued bonds, they may have a place in portfolios. We tolerate at least one hiccup in performance and prefer GARS to the Ruffer fund for this sort of strategy; (1) GARS would appear to be slightly less correlated with equities and has all the tools of a hedge fund, other than borrowing, at its disposal and (2) Obviously Ruffer provide investment expertise in terms of their asset allocation choices (which, as members will be aware, at a very reasonable price can also be obtained from our website at ipsofactoinvestor.co.uk), but most of the exposure could be fairly easily recreated oneself using Exchange Traded Funds (ETFs). This is not true of the GARS fund where the strategies are more complicated. Also for this particular type of exposure it may not be desirable to be exposed to the potential for discount widening in a closed end fund. Other similar funds to GARS are the Invesco Perpetual Global Targeted Return Fund and Aviva Multi-strategy Target Return Fund.
David Liddell 21.09.16