'Absolute return' funds aim never to fall. In choppy markets the appeal is clear but do they succeed?

By Richard Evans
The Telegraph Online & The Sunday Telegraph

Sunday 5 August 2012

Most private investors have heard of Neil Woodford but have you ever heard of Guy Stern? Mr Stern's fund, Standard Life Investments' Global Absolute Return Strategies, which he runs with his team, has just overtaken Mr Woodford's famous Invesco Perpetual High Income fund in terms of fund size.

Remarkably, the Standard Life fund is just four years old, whereas Mr Woodford's stalwart opened for business in 1988.

The Standard Life fund, often known as Gars, is the biggest of the new breed of absolute return funds, which aim to deliver positive returns to investors whether markets rise or fall.

It's not hard to see why investors have flocked to them in recent years, when share prices have plunged repeatedly with each new phase of the financial crisis.

Even a manager as good as Mr Woodford, by contrast, will see his portfolio knocked in a stock market sell-off when all shares are dragged down.

But are investors making a canny move if they seek to limit their losses by buying absolute return funds? Or would they be better off with a good conventional manager who will, over the long term, pick the stocks that deliver rising income and capital growth?

According to detailed research published by a firm of financial advisers last week, only three absolute return funds are worth considering. This represents just 6pc of the sector of 51 funds. ......

Many successful investors say don't buy anything you don't understand. In seeking to defy market gravity, some absolute return funds employ complex and often incomprehensible strategies.

Try this extract from a recent update on Standard Life's Gars fund: "We closed the broad market exposure as well as the long Eurostoxx exposure. Instead, we opened a new short position in European senior financials, meaning the new strategy is long exposure to subordinated financials credit, and short senior financials credit and bank equity.

Now look at the prospectus for Mr Woodford's fund: "We continue to focus the portfolio on what we believe to be fundamentally cheap companies, many of which are defined as blue-chip and where we believe valuations continue to underestimate their ability to grow through a prolonged period of economic stagnation."

Most investors will find Mr Woodford's approach a lot easier to understand.

While Gars, in common with many other absolute return funds, uses derivatives to "short" particular assets, others use different means to achieve the same ends. Some do not use any shorting, instead investing in a mix of asset classes to minimise the chances of sharp falls across the portfolio as a whole. ......

One adviser expressed concern about the growing size of the absolute return sector. Alan Steel of Alan Steel Asset Management said: "I am alarmed at the inflows to this sector and this [Gars] fund by folks who should be more careful. Many advisers admit that they don't know how the fund is constructed."

In March the Financial Services Authority said absolute return funds were of "potential concern". A spokesman said the regulator was worried about the growth of the sector, the possibility that investors would think that positive returns were guaranteed and the danger of investors and advisers not understanding the funds. It expects to publish the conclusions of its review later this year. ......

Quote courtesy of The Telegraph Online & The Sunday Telegraph
Sunday 5 August 2012