Absolute return strategies have been under the spotlight recently. However a key question is ‘to what extent are the funds similar in their management, outcomes and responses to market conditions?’
Ruffer is one of our more recent DFM partners and their portfolios operate according to an absolute return strategy. With this in mind, we thought we would take a closer look at the question. Our first stop was to ask our colleague, Gill Hutchison from The Adviser Centre about the analysis of absolute return funds.
This was her response:
From a fund selector’s point of view, the analysis of absolute return funds is not a straight-forward task. When we look at the IA Targeted Absolute Return sector, home to the majority of such strategies, this challenge is writ large. This sector is a collection point for a highly disparate range of funds that boast eclectic credentials, bound only by the IA’s requirement to achieve a positive return over a timeframe not longer than three years. Alongside Volatility Managed, it is the only IA sector that is defined by an outcome, rather than by asset class exposure.
The IA’s three-year time horizon means that investors should not expect positive returns quarter in, quarter out (unless, of course, the fund manager has been heroic enough to set that expectation!). Equally, a fund’s annual return target is often couched in terms of a three-year rolling objective, or a return to be achieved over the long term, which means that in any individual year, it is eminently possible that the objective will not be met.
This speaks to the importance of setting out the expected customer journey of a fund in glorious technicolour. Some absolute return funds are appropriate for cautious investors who are nervous about drawdowns and have modest return expectations. At the other end of the spectrum, the managers of other funds are content to embrace risk and at times, their portfolios are highly correlated to risk assets. This does not detract from the three-year absolute return aspiration, but it does mean that investors in these funds need to be prepared for higher volatility and deeper drawdowns. This wide variety of mandates is reflected in the KIID SRRI scores for funds in the sector, which lie across the entire range from 2 to 7. Maximum drawdown statistics reinforce this point: over three years from August 2015, the largest drawdown of a fund in the sector is almost 30%, while the smallest is just 1% (source: Morningstar Direct).
These facts and figures remind us that absolute return funds are idiosyncratic and need to be assessed according to their own merits. Analysis should include an understanding of a fund’s asset class exposures, risk parameters and sensitivity to market moves (directionality). Only then, alongside an appreciation of the market backdrop in which the fund manager is operating, can a strategy be judged fairly.
On that note, absolute return funds have received their share of criticism in recent months as, taken in aggregate, risk and/or return outcomes have often not met investors’ expectations. When we consider some of the dynamics at play, we are not surprised by this: bond markets have been distorted by QE activities; equity markets have seen narrow leadership; value stocks seem unable to close the enormous valuation gap with growth stocks; gold is at a 17-month low and has lost its safe-haven allure. These are challenges for all managers, but they are more vexing for managers who are unable to rely upon long-only beta to carry their portfolios along. Absolute return funds worth their salt will demonstrate their value during a sustained period of negativity for risk assets. When that time comes, investors will be pleased to have saved a portion of their portfolios for alternative outcomes.
Gill makes some really interesting points about the sector. We then spoke to Toby Barklem to understand the Ruffer view on absolute return strategies and what their approach is;
“At Ruffer the term ‘absolute return’ represents our central insight that most clients have needs that are not related to the behaviour of an index. For many with wealth, the first goal is to preserve that wealth, then make a return.
A lot of the criticism around ‘absolute return’ strategies has been as a result of expectations being set and consequently not met. We are very conscious of this. As a result we avoid identifying numerical targets and we do not suggest that our returns are ‘smoothed.’ Equally we understand that our investment approach is not suitable for everyone and, as such, we do not try to be all things to all people.
We have two simple investment objectives; not to lose money in any rolling twelve‑month period and to grow funds at a higher rate than would be achieved by depositing them in cash. Over the past 24 years our long term performance shows that this indirect method of ‘never losing money’ has worked, as we have delivered an annualised return of 9.1%. But over any 12 month rolling period, it sometimes hasn’t – with seven periods of negative returns but only once has a year–on–year fall exceeded 5%.
At Ruffer we believe booms and busts are an inseparable feature of financial markets, and whilst it is possible to spot what will cause the next crisis, it is impossible to know when it will be. Inspired by this belief we construct our clients’ portfolios with a blend of growth and protective assets, colloquially ‘greed and fear’.
Greed assets allow our investors some participation in the positive returns available during periods of benign market conditions. Fear assets defend these returns from specific, long term risks that we observe. Balancing the composition of these offsetting assets has allowed us to preserve our clients’ capital through the difficult market conditions in 2000 to 2003 and 2007 to 2009, delivering a return substantially ahead of the ‘risk free’ alternatives.
What this means for the assets in the portfolio depends on the conditions we see around us. Generally we try and achieve our aims through traditional asset classes like bonds and equities. More importantly for our approach, we aren’t compelled to own any specific asset classes and we have therefore been able to avoid manias as they have arisen. Avoiding banking stocks in the run up to the last financial crisis would be a good example.”
This article was created by DISCUS for Ruffer, one of our discretionary manager partners. You can find out more about their services by visiting Ruffer’s dedicated page or by running a comparison in the DISCUS Compare tool.