High charges and poor performance make these funds an unattractive option.
Today's article on alternative investments takes a look at absolute return funds. Investors hate losing money, but for much of the last decade that is precisely what conventional funds have done. Great big losses. In the economic 'perfect storm' of 2008 even the cautious managed sector lost money.
Never one to miss a trick, those clever folks in the fund management industry took a long hard look at their shrinking assets and came up with the investment equivalent of the Holy Grail; absolute return funds. Guess what? They make money even when markets decline. Needless to say it was the second best selling sector of 2008. But are these funds any good?
Taking advantage of all market conditions
Conventional unit trusts and OEICs are 'long only' funds; they can only buy, hold and sell shares, bonds or other assets. Their only option during a market crash or a prolonged bear market is to sell shares and hold cash. While this may mean that losses are less than the stock market as a whole, that is little consolation to the investor who can no longer afford a holiday, a new car or school fees.
Absolute return funds can do something rather special. By using complex derivatives they are able to effectively short sell shares or markets. So if (and it's a whopper of an if) they get their timing right and the market goes down, they can gain exposure to a position that increases in value.
If a fund is worth £1 million, a bearish manager might hold £600,000 of 'short' positions and £400,000 of 'long positions'. Should the market fall by 20% his £600,000 becomes £720,000, his £400,000 becomes £320,000 and he generates an absolute return of £40,000 or 4%. In this example, had the market risen by 20% he would have lost £40,000 or 4%.
If that sounds straightforward, it isn't. Some of these funds are focused on bonds, some on equities and others on currencies. They adopt a wide variety of objectives such as: 'LIBOR plus 2%', 'cash plus 1%', '6% to 10% a year'. Some aim to provide a positive return every year, others aim to provide positive returns over rolling three-year periods (not very ambitious that last one).
The common thread is that absolute return funds claim to be an investment for any and all seasons. Well call me a grizzly cynic but if that's the case why weren't we deluged with launches prior to the latest bear market? Let's leave that inconvenient question hanging in the air and look at performance.
Performance has been mediocre at best
In the table below I present the total return from UK equities (including re-invested dividends, sourced from the Barclays Gilt Equity Study), the average absolute return fund (data from Trustnet) and the HSBC Money Market Fund, from 2004 to 2008.
| Year | UK Shares | Absolute Return | Money Market |
|---|
| 2004 | 12.5% | 12.6% | 3.3% |
| 2005 | 21.6% | 10.5% | 3.7% |
| 2006 | 16.4% | 5.4% | 3.4% |
| 2007 | 5.1% | 7.2% | 4.9% |
| 2008 | -29.8% | -1.8% | 4.6% |
Well, the absolute return funds do point out that they are likely to underperform a bull market. Sure enough they did just that. But then we hit the investment nightmare that was 2008 and they beat the index. But they neither delivered an 'absolute' return, nor did they beat cash. It is not unusual for these funds to charge between 2% and 3% a year plus performance fees. I question whether it's worth paying that to underperform in 50% of bull years, and not beat the building society in a dog year.
If you're such a nervous, or conservative, investor that you want (or need) an absolute return each year why not just go for cash, or maintain a sufficiently large holding of cash? If you want the rewards of equities why not just buy shares? And if you want to reduce risk achieve it through low cost asset allocation. As I've pointed out in Feeling Cautious? Load up on Gold a simple 25% split between gold, UK shares, deposit accounts and gilts in 2008 would have returned 5.8% and has a consistent 36-year track record. Funny how commission based advisors don't mention that sort of thing, eh?
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