Why should investors consider absolute return funds?

Targeted absolute return funds may appear to be the perfect investments. Their aim is to make you money, irrespective of what happens to global stock markets.

For investors looking for portfolios that can steer their way through volatility and economic uncertainty, it’s a sales pitch that will sound very seductive.

However, it’s a complicated area. Funds in the IA Targeted Absolute Return sector take different approaches in the pursuit of their goals – and not all will be successful.

Here, we take a look at the sector and highlight some funds that might be worth considering.

What are absolute return funds?

Targeted absolute return funds aim to deliver positive returns in any market conditions. It’s important to note that these positive returns are ‘targeted’ but aren’t guaranteed.

According to the IA Targeted Absolute Return sector rules laid down by the Investment Association, the return achieved must also be more demanding than a ‘greater than zero after fees’ objective.

Funds in this sector must also clearly state the timeframe over which they aim to meet their stated objectives. However, this mustn’t be longer than three years.

How have they performed?

It’s fair to say that returns have been rather mixed. The best performers have delivered up to 35% positive returns over the past year*. However, the worst performers are in negative territory to the tune of -14%*. That’s quite a stark difference and illustrates the importance of doing your homework.

Overall, the data shows that 59 funds have made positive returns for investors over the past year, while 46 have lost money*.

Of course, it’s important to remember that not all funds in this sector are aiming for positive returns over 12 months. Some, for example, focus on rolling three-year periods.

Research is required

The differing investment approaches taken by funds in this sector makes it impossible to accurately compare one fund with another or view the sector as a realistic benchmark.

You need to drill down to understand how the individual funds work, what they invest in, and the risks they are taking. Here we look at four Elite Rated funds in the IA Targeted Absolute Return sector that might be worth considering. Each has recorded positive returns over the past 12 months*.

Research all of FundCalibre’s Elite Rated, Radar Targeted Absolute Return funds and Absolute Return Funds

Janus Henderson Absolute Return

This fund has a simple aim: to provide a positive absolute return, regardless of market conditions, over any 12-month period. However, it also makes clear that this result isn’t guaranteed.

The managers, Ben Wallace and Luke Newman, invest in shares, as well as making use of complex derivatives to take both long and short positions. This allows them to make money if stocks either rise (long) or fall (short) in value. In this way, the overall construction embraces a more flexible approach.

Typically, at least 60% of the exposure to the long and short positions (in aggregate) will be to companies of any size, in any industry, in the UK. Up to 40% may be to non-UK companies.
The fund will also have a significant proportion of its assets in cash and money market instruments as a result of holding derivatives and for when a defensive stance is desired.

Sanlam Enterprise Fund

This is a long/short fund that primarily invests in the UK. The fund’s experienced managers, Mark Boucher and Mark Swain, focus on generating returns through both their long and short positions. The stated objective is to achieve positive returns on a rolling 12-month basis, albeit with lower risk and lower volatility than the UK stock market.

Reasons to invest in the fund include gaining exposure to interesting stocks and themes, as well as the fund’s pragmatic investment approach, according to Sanlam. Another attraction is the provision of portfolio diversification with low correlation and low volatility focussing on capital protection.

According to the fund’s most recent factsheet, its most significant long position is in AstraZeneca, the global pharmaceutical giant**. Other prominent names in the top 10 include 3i Group, Ferguson, Ashtead Group, Watches of Switzerland, and Diageo**.

BlackRock European Absolute Alpha

This fund, which is managed by Stephanie Bothwell and Stefan Gries, aims to achieve positive absolute returns over 12 months, regardless of the market conditions. The managers have a flexible approach and a key focus on capital preservation, low correlation and low levels of volatility. This is achieved by investing in companies whose share prices they think will rise (longs) and by ‘shorting’ stocks where they believe the share price will fall.

An attraction of this portfolio is its pan-European mandate. This gives it a very wide range of opportunities – further enhanced by embracing both long and short ideas. This is illustrated by its top 10 holdings. The names include European heavyweights such as pharmaceutical firm Novo Nordisk, beauty giant L’Oréal, and luxury group LVMH**.

The fund’s philosophy is to focus on capital preservation, meaning the managers are looking to protect more than to excel. This may result in the fund performance being more modest than some of its more high-octane peers.

Brooks Macdonald Defensive Capital

Long-term capital growth and protection is the name of the game for this defensive, multi-asset fund. It aims to deliver positive absolute returns over rolling three-year periods, in a range of market conditions, with less volatility than equity funds.

While the types of assets that this fund holds can be a bit complicated—convertible bonds, preference shares, structured notes, bond and loan assets, and discounted assets—the goal of delivering positive total returns, regardless of market conditions, is straightforward enough.

The manager seeks to create a portfolio with ‘predictable’ performance by investing in assets that have fixed returns. He is careful not to overpay and will always try to buy assets when they are trading below their intrinsic value. The manager also keeps a close eye on the portfolio mix and won’t hesitate to sell one of the holdings if its yield drops unacceptably, or if it seems likely to move in tandem with falling markets.

*Source: FE fundinfo, total returns in sterling, one year to 23 March 2022
**Source: fund factsheet, 28 February 2022