The investment fund sector that leaves you short of money and peace of mind.
A few years back, IFAs declared absolute return funds to be absolutely fabulous, and started vigorously selling them to their clients.
It was the second most popular investment fund sector in 2009, attracting £1 for every £10 interested in funds, according to the Investment Management Association (IMA). Only corporate bond funds were more popular.
When the figures were published, I wrote a feature suggesting this sector was, in fact, absolute nonsense, because it offers investors the illusion they can earn money whatever happens to stock markets.
This is like saying you can get a suntan even when it is raining, I noted at the time.
I also warned that absolute return funds are neither cheap nor transparent, given that some charge as much as 2% or 3% a year. That alone would be enough to deter even the most credulous Fool.
Absolutely not very fabulous
Everybody likes having their prejudices confirmed, so I was interested to see a new piece of research reporting on a massive "absolute return letdown".
The research, from Thames River Multi-Capital, said the sector suffered "miserable returns" in the last three months of 2011. It returned a meagre 0.2%, making it the fifth worst performer out of 36 IMA sectors.
This wasn't just a three-month blip. Over what was a very volatile year, the sector fell -1.2%.
Happy when it rains
Still, that's only one year. How has the sector done over longer periods? Thames River doesn't say, but I've examined sector IMA figures on Trustnet.com in the table below, and my prejudices have (mostly) been confirmed.
True, absolute return did spare its investors the full trauma of 2008. Across the calendar year, the sector fell just -3.6%. That compares to a brutal drop of -10% for sterling corporate bond funds, -32% for the UK All Companies and -37% for global emerging markets.
So when the heavens opened, absolute return did help to keep investors dry.
But when the sun burst out again in 2009, absolute return was left in the shade. The UK rose 30% and global emerging markets rocketed 57%, but absolute return crept up a modest 8%.
That said, absolute return is designed to smooth out the peaks and troughs stock market investment, and investors have to accept it will underperform in the good times.
| Sector | 2008 | 2009 | 2010 | 2011 |
|---|
| Sterling corporate bond | -9.7% | 14.3% | 7.6% | 4.4% |
| Global emerging markets | -36.7% | 57% | 23.6% | -19% |
| North America | -18.4% | 19% | 17.4% | -1.6% |
| UK All Companies | -32% | 30.4% | 17.5% | -7% |
| Absolute return | -3.6% | 8.6% | 4.3% | 1.3% |
Absolute nightmare
I still wouldn't touch the sector, and my second table will show you why.
Absolute return would have shielded you from the worst volatility of the last five years, but at a cost. Even over the five-year spell that includes the crash of autumn 2008, sterling corporate bonds, the US and global emerging markets offered a much better return. Only the UK All Companies fared worse.
And over the last three years of tentative recovery, absolute return has been absolutely hammered. The average corporate bond returned four times as much. The US returned four times, the UK five times and global emerging markets a mighty seven times as much.
| Sector | Cumulative three-year return | Cumulative five-year return |
|---|
| Sterling corporate bond | 36.4% | 18.7% |
| Global emerging markets | 83.9% | 45% |
| North America | 47.8% | 19.8% |
| UK All Companies | 60.7% | 3% |
| Absolute return | 12.8% | 14% |
Ab-flab
Absolute return does give you short-term protection against major shocks, but at huge expense (and I'm not just talking about those management fees).
If you're investing for the long term, absolute return is likely to lock you out of the full benefits of investing in stock markets.
In fact, you would be better sticking to cash. If you took out a five-year fixed-rate investment bond paying 4.5%, you would get a cumulative return of 24.6%.
That's far better than the 14% you would have got with the average absolute fund over the last five years.
Absolute lottery
Gary Potter at Thames River agrees with me. He says the very least absolute return should do is give returns above cash. It hasn't.
Another drawback, he says, is that absolute return funds vary hugely in terms of strategy, geography, positioning and where they invest. This makes it hard for investors to compare funds, and understand what their own fund is supposed to do.
You could say that of any investment sector, but absolute return is supposed to give investors peace of mind, but that leaves plenty of room for uncertainty.
Individual fund performance is also massively variable. The best performer over the last five years, Newton Real Return, delivered 44%. The worst, BNY Mellon Evolution Global Alpha fell -14%.
The risk is there, even if the returns aren't.
Happier returns
Absolute return is more likely to line the fund manager's pockets than yours. Investing in equities does carry more risk but, ironically, less danger -- provided you are investing for the long term.
Better still, you aren't paying big bucks for tricky investment techniques such as short selling, futures, options, derivatives, arbitrage, leverage and unconventional assets.
Which is absolutely fine by me.
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