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Forget absolute return! A Stocks and Shares ISA is the best way to top up your State Pension

Every so often, the financial services industry reckons it has discovered a way of offering investors the best of both worlds.

Absolute nightmare 

It convinces itself it can offer savers a better return than cash, but without the risk of investing in stocks and shares. So instead of 1% a year you might get 4% or 5%, regardless of whether markets rise or fall.

You can see how seductive this is. Especially in the hands of an independent financial adviser faced with clients demanding the highest possible return with the minimum possible risk.

The problem is that the best of both worlds typically gives you the worst of each. Remember with-profits bonds with their famous smoothing effect? Or precipice bonds, paying high levels of guaranteed income?

The latest attempt has also come unstuck – absolute return funds. Astonishingly, this was the biggest selling sector in both 2015 and 2016.

Head for the exits!

Over the last five years I have written a string of articles slamming the sector, with headlines such as Absolute return funds are still absolute rubbish, only for it to perform even worse than I anticipated.

Now the message is finally hitting home, as investors flee these over-hyped funds in droves amid continuing dismal performance. In the last 11 months, they have pulled out £5.4bn, according to new figures from online platform AJ Bell.

Global absolute rubbish

The sector’s biggest fund was its biggest disaster. Incredibly, Standard Life Investments Global Absolute Return Strategy (GARS) managed £26bn at its peak, but has now shrunk to just £8.2bn as savers bolt for the exits. Over the last five years, it returned a meagre total of 5.8%, below inflation at 7.68%, so savers have lost money in real terms.

The only people to consistently make money out of absolute return are the fund managers, who charge hefty annual charges and maybe performance charges on top.

Absolute return funds try clever tricks such as shorting stock markets and buying complex financial derivatives in a bid to produce a positive return year after year, even if stock markets are falling. Their dismal showing is yet another nail in the coffin of active fund management, following the ongoing suspension of Neil Woodford’s flagship fund LF Woodford Equity Income.

Can’t be done

The underlying problem is that absolute return funds are trying to square a circle – delivering high returns with low risk. They can only do this by slapping on layer after layer of complexity, for example, shorting stocks and trading derivatives.

The problem is that people ain’t that clever, even highly paid fund managers. Nobody can consistently time the market, because nobody knows the future, and they shouldn’t pretend otherwise.

Wise investors know this and stick to asset allocation instead. This involves building a balanced portfolio of different assets including stocks and shares, bonds, cash and property, but in particular, shares, which offer the best long-term return.

Stock markets will be volatile in the short run. Your holdings will fall in value at some point, but nobody is pretending any different. The lower-risk asset classes can provide some balance, the rest is down to time. If you invest over 10, 20 or 30 years, as you should, history shows that share prices will climb significantly, making you richer.

It isn’t magic, and doesn’t rely on fund manager genius. It just works. Absolutely.

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Harvey Jones has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.