Beware funds that promise both protection and growth

Investors anxious about the economic outlook are turning in growing numbers to funds that promise both protection and growth '“ but which also have a habit of failing to deliver.

The targeted absolute returns sector has faced criticism of poor performance, high charges and a lack of transparency. Picture: PA

The “targeted absolute returns” sector has been the most popular among ordinary investors in eight of the past 12 months, according to the Investment Association, attracting more money than any other fund type.

The trend reflects increased nervousness about market volatility, the lack of returns on cash and, more recently, the implications of the EU referendum outcome. Investors are attracted to the funds by their stated aim of providing positive returns regardless of market conditions. The sector houses almost 100 funds that use a variety of methods to produce returns and manage volatility, with the launches coming thick and fast in the wake of the financial crisis.

“A ‘cash plus’ investment return is easy for an investor to understand; together with lower volatility than an equity fund, who would not be attracted to a positive return in all market conditions?,” asked Charles Robertson, senior investment manager at Murray Asset Management in Edinburgh.

But these funds have more than their fair share of critics, who point to poor performance, high charges and a lack of transparency.

The average fund in the sector is up just 0.6 and 7.9 per cent over the last one and three years respectively, according to Trustnet. Perhaps the best known is the massive Standard Life Global Absolute Return Strategies (Gars) fund, with more than £26bn under management but which has underperformed the sector over the past year.

“A recent US report on Absolute Return funds found if a fund had the word ‘absolute’ in its title it should be avoided at all costs, given their pathetic record over the last three years in particular,” said Alan Steel, chairman of Alan Steel Asset Management in Linlithgow.

The funds have the ability to use assets from equities and bonds to derivatives, currencies and other opaque investment tools. That can help them protect against volatility risk, but it can be hard for investors to compare products and understand what they’re buying as different funds can take very different approaches to using the various strategies.

“We’ve found from experience that when fund managers can’t (or won’t) describe what they’re doing or investing in, it’s time for a sharp exit,” said Steel.

While some will invest mostly in equities, for example, others are more bond focused, some are mixed-asset funds and several rely heavily on derivatives. The top performers over the past year are Schroders funds investing in emerging market and Asian debt, followed by a Polar Capital fund investing mainly in UK and European equities.

“The fund may employ a number of complex investment strategies across various asset classes including bonds, equities and currencies. You can’t read any literature on a fund without seeing multiple statements that ‘a positive return is not guaranteed’,” said Robertson.

Investors will invariably focus more on the stated aim of “a positive return in all market conditions”, he said.

“However year-to-date just under half of the funds have delivered a negative return (the worst is down 21.6 per cent but the best is up 31.1 per cent). Investors need to be patient with this type of fund and appreciate the timescale of the fund’s investment objectives.”

One advantage of absolute return funds is that they often have a low correlation with equity and bond markets. Investors would expect them to perform relatively well at times of stress in the market, said Robertson, but they might be disappointed.

“In February and March of this year when equity markets moved lower, a number of targeted absolute return funds experienced a significant and often unprecedented decline in their prices and so did not provide the hoped for ‘diversification benefit’.”

In other words, while absolute return funds can reduce downside risk, investors can’t expect too much in the way of investment returns. So if these funds appeal to you, the key is to understand what you’re investing in, do your homework and make sure the charges aren’t so high that they wipe out the gains made. Advice is highly recommend, if possible.

“Look for funds where the underlying fund management group has a strong track record in the asset class concerned, and where the lead manager has experience of market cycles,” said Robertson.

“A significant excess positive return, although welcome, may imply that there may be more capital risk involved than initially apparent.”