The Targeted Absolute Return sector has come in for another kicking: it is subject to a regulatory review and is currently suffering its worst relative performance since the Financial Crisis. Is this criticism fair?
Although the theory of absolute return funds is fine, it has proved more difficult in practice. Monetary easing since the financial crisis has skewed investment returns and investors have sought safety at almost any price, whilst showing a casual disregard for fundamentals.
- Absolute return investment relies on financial markets behaving in a certain way; it cannot accommodate a shift in the environment
- Managers have had to predict the impact of an unprecedented monetary experiment on financial assets
- Generating alpha is difficult and many active fund managers haven’t participated in rising markets while still experiencing savage drawdowns
Absolute return funds, in essence, means investors go long in those assets that they believe will go up and short of those assets they believe will go down. This is not simply logical – it would seem to be sound investment practice; far sounder than, say, going over- or underweight a benchmark.
So why has it proved so difficult in practice? Markets have not been kind. Monetary easing since the financial crisis has skewed investment returns. Investors have shown some casual disregard for fundamentals and, in many cases, valuations, seeking out safety at almost any price.
This has been difficult for absolute return managers across the board. Managers have had to predict the impact of an unprecedented monetary experiment on financial assets. That said, perhaps this is part of the problem of absolute returns – it relies on financial markets acting in a certain way, and cannot accommodate a shift in the environment.
There is another explanation that it is a little more unflattering. It is that generating alpha is difficult and many active fund managers can’t do it. Some funds have delivered the worst of all possible worlds – they haven’t participated in rising markets, while still seeing savage drawdowns. Because these drawdowns can come at any time, investors’ disappointment is all the more acute.
There is also a problem of description. Absolute return sounds, well, like you’re going to deliver an absolute return. Most caveat this by saying they will achieve positive returns over three-year rolling periods, but this gives no indication of the type of losses an investor might experience along the way.
Equally, low volatility is highly prized, but there is an argument to say that this doesn’t mean a lot in terms of long-term real returns. Volatility is an inadequate measure and is not how most investors perceive risk. Permanent loss of capital is a far greater fear for most investors.
I suspect one other problem is that a particular large fund that shall remain nameless has become something of a proxy for the reputation of the sector as a whole. If it suffers, investors fret about the wider concept of absolute return. Investors might do well to reflect on some of the success stories: Henderson, Schroders, Threadneedle and Baring all have funds in the sector that have steadily delivered returns with low volatility and low drawdown. Let’s not forget about those as the sector comes under scrutiny.