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June 2015 - Targeted Absolute Return

We should get used to periods of higher volatility,” Draghi said at a press briefing in Frankfurt last Wednesday. “At very low levels of interest rates, asset prices tend to show higher volatility.

And the bond market swooned. Well blow me down I thought they taught this stuff at prep school! It just goes to show that when momentum is your friend and markets appear to be a one way bet, then all rational thought goes out of the window.

Bond maths are baffling for most of us, but it is fairly obvious that a move from 1% to 2% is going to cost you a lot more than one from 9% to 10%. 10% bond yields! Oh those were the days…along with double digit inflation…Draghi is just pointing out the blindingly obvious, but it is just as well that someone did, it is just a touch ironic that it was him. But then bond world hangs on to his every word; all very reminiscent of that past eminence grise Alan Greenspan - another of the central bank bubble blowers.

The move from the lows (0.05%) in yield for the German 10year to the current 0.88% represents an 8% loss for bond holders. Such a short-term move in equity prices often comes with the territory, but such is the asymmetric risk for bonds – you won’t get the “unlimited” upside that you can get with equities - that this is starting to get very painful.

The longer the duration the more painful it gets and German 30year losses are around 20%. Ouch! So far the fall out has been limited in the main to sovereign debt, especially in the eurozone, and has not reached out into corporates and high yield partly because the euphoria following the ECB QE announcement didn’t affect those sectors. However, the volatility in bond world is such that the message is beware! If sovereign yields continue to rise then there will most certainly be a knock on effect further down the food chain and this will be exacerbated by the shrinking of liquidity in these markets.

German government 3.25%

Ben Graham had this to say about the definition of investment:

“An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.”

He was in all probability referring to equities, but it might give bond “investors” pause for thought if they consider that by Ben Graham’s definition, what they are really dealing in is highly “speculative”.

So what is an investor to do? Alternatives abound, but we are not talking about fine wine or works of art where prices are even more ludicrous. The Target Absolute Return sector is beginning to throw up some interesting candidates. Many funds in this sector are targeting equity-like returns with much lower volatility. They do this in the main by employing a number of non-correlating strategies. This doesn’t make them totally immune to sudden changes in market direction, but does help in that all their trades won’t be facing the same way. Their losers will in the main be balanced out by their winners.

At the lower end of the volatility scale we have Premier Defensive Growth, managed by Paul Smith, and the Church House Tenax Absolute Return fund, managed by James Mahon and Jeremy Wharton. All three managers are acutely aware of the need for preservation of capital and follow a multi-asset approach. Further up the risk spectrum come Old Mutual Global Equity Absolute Return, managed by Ian Heslop, Smith and Williamson Enterprise, run by Rupert Fleming, and Henderson UK Absolute Return, run by Luke Newman. As their names suggest these are more equity-orientated funds although managed with an absolute return mindset. They target higher returns than the multi-asset funds over the longer term and there will be periods of drawdown. All these funds are Elite Rated by FundCalibre.

Performance of discussed funds against IA Targeted Absolute Return sector and LIBOR GBP 1m TR in GB

As an alternative to “speculative” bonds Target Absolute Return funds have an important part to play in portfolio construction.


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Clive Hale, Director – June 2015

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