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Selectors retain faith in absolute return despite losses

Appetite for absolute return strategies still high despite underperformance but Gam fiasco may test investors’ patience


Jassmyn Goh

It’s been a rocky period for absolute return funds. Swiss manager Gam’s high-profile liquidation of its €9.5bn Absolute Return Bond fund range made headlines this month. Standard Life’s flagship €17.4bn Global Absolute Return Strategies (Gars) fund, meanwhile, has consistently underperformed, prompting large outflows.

The term ‘absolute return’ should not to be confused with ‘unconstrained’ even though they are often used interchangeably – the former refers to an outcome, the latter to a style of investing.

Unconstrained bond funds have had two successive quarters of negative European fund selector sentiment, according to Last Word Research.

However, fund selector appetite for absolute return strategies has remained consistently high over the last three years.

Last Word Research’s latest asset class survey found that in Q2 40% of pan-European selectors said they were looking to increase their allocation towards the asset class over the next 12 months.

Another 35% said they were looking to hold their allocation, 4% to decrease, and 22% did not use the asset class.

These numbers have been remarkably consistent since Last Word Research began surveys in 2015 and there has never been more than 7% of selectors looking to decrease absolute return allocation (in Q2 2016 and Q3 2016).

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Source: Last Word Research

“Appetite for the broad absolute return asset class is showing little sign of disappearing with 40% to 50% of respondents saying they expect to buy more in half of the countries surveyed,” the survey said.

“Even in countries with below average usage, you would find keen buyers.”

Longest bull market ever

Tim Peeters, head of securities portfolio at Belgian multi-family office Portolani, told Expert Investor that he was looking to increase his absolute return strategy allocation to help cushion the next downturn.

This week marks the longest bull market on the S&P 500 in history and Peeters said that likely portends tighter financial conditions.

“As asset classes like bonds and equities rise to unsustainable levels it means investors need to search for places to hide, as both asset classes might fall together,” he said.

“In traditional funds the bond part of the portfolio is meant to cover some of the equity side losses in case of a stock market collapse. With nearly no yields left, bonds cannot provide this ‘cushion’ role as they did over past decades.”

Correction risk

As the risk of a correction in bond and equity markets rises, absolute return funds provide the ability to diversify across asset classes and go short to hedge risks, Peeters said.

“Absolute return funds can have uncorrelated investment strategies which can perform on a standalone basis – the performance of a fund is the sum of these different uncorrelated strategies,” he said.

However, while such an approach sounds attractive on paper in the kind of “late stage, low volatile, low yielding market” we are in at the moment the results of many absolute return funds have been poor.

Paris-based founder of Iodda Advisors, Vincent Batailler, said his family office clients in Europe and Asia were keen on absolute return strategies because they provided an alternative to equity and bond funds.

“With absolute return funds [clients] are able to invest for a long period of time and put trust in the managers to get through difficult periods,” Batailler said.

“Absolute return funds can not only mitigate market movements but make nimbler and more interesting investments.”

July outflows

Looking at Morningstar fund flows data, the absolute return sector (including hedge strategies, multi strategy, volatility, arbitrage, currency, and event driven funds) since the beginning of 2018 has had inflows of €21.7bn.

Over the last 12 months to July 2018, inflows were at €50.1bn.

However, July 2018 experienced outflows for the first time since December 2011 at €834m. Multi-strategy funds experienced the largest outflows in the sector at €1.3bn, followed by long/short debt at €891m.

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Source: Morningstar

The largest inflows were from global macro funds at €910m and European long/short equity funds.

The multi-strategy fund with the highest outflows was Standard Life Aberdeen’s flagship UK-domiciled Global Absolute Return Strategies (Gars) fund at €600m. The fund’s Luxembourg-domiciled version came third in outflows at €400m.

UK-domiciled Newton Real Return fund came second with outflows of €457.9m.

While these outflows precede the Gam debacle, absolute return funds were already on a downward trajectory with June experiencing the lowest inflows at €720m since November 2016 (€565m).

Morningstar data showed that the Gam Star Absolute Return Bond Plus fund had outflows of €1.04m during July.

However, the Gam Star Absolute Return Bond and Gam Star Absolute Return Bond Defender funds had inflows of €82.5m and €26.6m respectively during July.

Since January 2007, almost every month the sector has been dominated by inflows with its highest in December 2015 at €10.2bn. The highest contributors during the December 2015 high were multi-strategy funds (€5.4bn) and market neutral equity funds ($2.5bn). The lowest being currency funds with an outflow of €226m.

Ucits due diligence

Batailler said the fact that absolute return funds were Ucits-accredited led to some investors concluding there was no risk.

“[The Ucits stamp] means some people invest in absolute return funds without any due diligence – without knowing what the managers do, what the risks are, and how the fund performs in different market environments,” he said.

“The biggest challenge for absolute return managers is if they have a portfolio which is not balanced. They have to pay attention to how the portfolio is constructed, and how to ward off any disillusions.”

Peeters said selectors should spread their investments over a number of different absolute return managers to mix up the strategies they are exposed to.

Poor absolute returns

While many absolute return strategies have not delivered stellar returns in recent years, Peeters said he expected this underperformance to be temporary, and said he expected the next market downturn would highlight the merits of diversification.

Multi-strategy funds would help investors survive the next market downturn, Peeters said, while long/short equity funds should create value.

Despite the asset class’s popularity, returns over the three years to 31 July 2018 have been abysmal.

The absolute return sector within the Offshore Mutual and FCA Recognised universes had losses of 4.8% and 6.4% respectively, according to FE Analytics.

Absolute return sector returns three years to 31 July 2018

Absolute return sector returns three years to 31 July 2018
Source: FE Analytics

The largest absolute return strategy funds, by assets under management (AUM), is Old Mutual Global Equity Absolute Return I Accumulation fund at €14.2bn.

The fund has performed the best out of the top 10 largest absolute return strategy funds at 11% over the three years to 31 July 2018.

However, the second largest fund, Standard Life Aberdeen’s Gars fund has lost 9% over the same time period.

According to Morningstar, this year alone the fund has lost €2.1bn in flows. Over the three years to June 2018, the fund has lost €4.7bn.

Standard Life’s Gars fund was the UK’s largest fund before it suffered massive outflows in 2017 after three years of underperformance. Last year, its Luxembourg domiciled version lost €6.4bn in net assets.

Despite the huge losses, the Gars fund is still among the largest funds in the asset class with €7.4bn.

Largest absolute return funds by AUM

Fund name One year to 31 July 2018 performance Three years to 31 July 2018 performance Five years to 31 July 2018 performance Fund size (AUM)
Old Mutual Global Equity Absolute Return I Accumulation 5.5% 11% 44.9% €14.2bn
Standard Life Aberdeen Global Absolute Return Strategies A Accumulation -4.4% -9% 1.3% €7.4bn
Invesco Global Targeted Returns A Accumulation EUR -2.5% 0.3% N/A €6.4bn
Schroder ISF Emerging Markets Debt Absolute Return A Accumulation NAV USD -1.6% 2% 16.8% €4.5bn
Aviva Investors Multi Strategy Target Return A EUR -1.04% -3.3% N/A €3.8bn

Source: FE Analytics

However, over the three years to 31 July 2018, only four out of the top 10 funds by size returned above 2.5%.

Among the largest funds that had five-year return figures to July 2018, all returned in positive territory, highlighting the merits of much longer-term investment horizon with absolute return funds. The Gars fund scraped through at 1.3%, and the Old Mutual fund at 44.8%.