Absolute return funds aim to make money whatever happens – and such a pledge will sound particularly seductive when times are financially tough. Sky high inflation, soaring interest rates, and looming fears of a recession have certainly made it a nervous start to the year for investors.
But where have the managers charged with delivering returns during such challenging periods been putting their money in recent weeks? In this piece we take a look at the positioning of absolute return portfolios and highlight some funds that are worth considering in this area.
Before we look at individual holdings, let’s have a recap about absolute returns and their potential role in investors’ portfolios.
These funds can be found in the IA Targeted Absolute Return sector. They aim to deliver positive returns in any market conditions, although returns aren’t guaranteed.
Returns must be more demanding than a ‘greater than zero after fees’ objective and funds must state the timeframe – no longer than three years – in which they aim to meet their objectives.
They may be in the same sector, but these funds will all be run very differently in terms of their overall goals and day-to-day management.
For example, some may be aiming to achieve positive returns over 12 months, while others will be focused on rolling three year periods. Some will try to achieve their goals by investing in just one asset class – like UK equities – and ‘shorting’ stocks (making money when share prices fall) as well as investing in them for the long term. Others will use diversification alone to achieve their objectives.
This makes it impossible to accurately compare like-with-like in this area. Would-be investors must drill down into the fund to understand how it works, what it invests in, and the risks taken.
Here we take a look at where three funds in the IA Targeted Absolute Return sector are focusing their attention.
This is a long/short equity fund, that can be found on the Chelsea Selection. It has a UK bias and aims to deliver absolute positive returns over rolling 12 month periods. The performance target of the portfolio, which is co-managed by Ben Wallace and Luke Newman, is to outperform the UK base interest rate, after charges, over any three year period.
Overall, the portfolio attempts to enhance the overall risk/return characteristics of a balanced portfolio, with a key focus on preserving capital.
In their most recent update, the managers noted the fund’s tilt towards the “comparatively stronger UK market” and strong stock selection helped performance in late 2022. Insurers Lancashire Holdings, Conduit Holdings, and Beazley all performed well due to a hardening in non-life insurance rates and the tailwind of rising interest rates.
“The long position in infrastructure group Balfour Beatty was also positive following a solid trading statement in excess of market expectations, with its management indicating a return of capital through share buybacks this year,” they noted.
Looking ahead, they acknowledged the likelihood of short-term volatility due to the Ukraine situation and disorder surrounding China’s reopening. However, their expectation for 2023 is for less extreme macroeconomic moves, with the belief that we’re close to a peak in interest rate hiking activity.
“We think that with this should come an equity market that is less driven by macroeconomics and more by stock specifics - an environment which has historically proven a fertile hunting ground for fundamental long/short strategies, irrespective of equity market direction,” they added.
The aim of this fund is to achieve positive absolute returns over periods of 12 months, regardless of the prevailing market conditions. In pursuit of this goal, co-managers Stefan Gries and Stephanie Bothwell embrace a fully flexible approach, with a focus on capital preservation and low volatility.
This is achieved by investing in European companies whose share prices are expected to rise, as well as shorting those predicted to fall. These synthetic short positions are achieved via derivatives that enable the fund to benefit from selling an asset it doesn’t own with the aim of buying it in the future at a lower price.
Healthcare is currently the most prominent sector in the fund with a 5.16% net position, followed by energy with 3.85% and the 3.54% in industrials*. France heads up the country exposure on 7.52%, followed by the Netherlands on 5.11%, Denmark with 4.23% and Switzerland on 1.67%*.
The fund’s 10 largest holdings, meanwhile, have similar weightings, with all of them between 1.79% and 2.43%*. This list includes pharmaceutical names such as AstraZeneca and Novo Nordisk, as well as personal care specialist L’Oreal, and luxury brand LVMH Moet Hennessy Louis Vuitton.
This is a defensive, multi-asset fund that aims to deliver positive absolute returns over rolling three year periods – and capital growth over longer time horizons. It does tend to be more volatile than many other funds in this sector and will still fall in poor markets - but it normally rebounds reasonably quickly.
The fund invests in alternative assets that do not necessarily rely on market growth for positive returns. These assets, which include convertibles, preference shares and structured notes, can appear to be rather complicated at first glance. However, its bottom-up approach to stock selection and top down macro views to guide asset allocation is a more familiar approach.
The fund also researches niche areas of the market in order to find investment opportunities that may be off the radar of some rival firms. Its manager, Dr Niall O’Connor, is certainly an experienced hand. He has more than two decades of investment experience and is celebrating his tenth year with Brooks Macdonald in 2023.
In a recent update, he suggested the macro data pointing to a recession was still an open question, while his portfolio remained “heavily skewed” towards value stocks. “We believe that value will continue to outperform growth even in a mild recessionary environment,” he wrote. “Valuations are already discounting a slowdown in our view. Absent a deep global recession, we still see upside to the fund’s holdings.”
*Source: fund factsheet, 31 December 2022
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views expressed are those of the author and fund managers and do not constitute financial advice.