One in three absolute return funds lost money in 2020

Absolute return funds are designed to protect capital, but have once again disappointed. 

One-third of absolute return funds have lost investors money so far this year, in a disappointing showing from portfolios that are designed to achieve a positive return regardless of market conditions.

Of the 108 funds in the Investment Association’s Targeted Absolute Return sector, 35 have lost money since the start of the year (up to 25 November), that’s 32% of funds in the peer group. During the sell-off in the first quarter, when they might have been expected to offer investors some downside protection, the majority of funds also recorded a fall.

What the year-to-date figures highlight is the wide divergence in performance and in the types of investment strategies used by absolute return funds, which makes the sector difficult to navigate for the average retail investor.

Since the start of 2020, 10 absolute return funds have managed to deliver a return of more than 10%, showing that some products take a much more aggressive approach rather than just aiming for capital protection. The best-performing individual fund year-to-date is LF Odey Absolute Return, up almost 30%, while the worst performer is Jupiter Absolute Return, down almost 20%.

• How ‘defensive’ trusts have performed during a turbulent 2020
• Ian Cowie: how 15 trusts I own have fared since Covid-19 sell-off

Diverse returns

Some professional investors find this wide dispersion of returns and strategy off-putting because it makes it harder for them to forecast when absolute return funds will do well, and when they will underperform. Chris Rush, investment manager at IBOSS Asset Management, says his team no longer holds them for this reason.

“A problem we have with them is that you can look at historic performance and say ‘these were the good funds and these were the bad funds’, but because their positions change so frequently over time, there’s no way we can extrapolate that data into the future,” says Rush. As positions change so much, investors end up at the mercy of individual fund manager’s whims, and can only hope they make the right decisions, he adds.

Complex strategies

The funds can also be hard to understand – some absolute return fund managers adopt hedge fund-style strategies using complex tools such as derivatives, leverage and shorting to achieve returns.

Richard Cole, fund manager at Future Money, says even professionals can struggle to get their head around how some of these strategies work. “We’re not overly keen on the Targeted Absolute Return sector because you don’t know what you’re going to get with each strategy – the range of techniques can be mind-boggling even to those of us who work in the industry, so it will be nigh on impossible for a retail investor to know what’s driving performance.”

While absolute return funds can still have a place in portfolios, the key to avoiding disappointment is knowing what they are trying to achieve and how they do it, Cole suggests. “Some funds will aim to deliver cash plus 1% or 2%, while others are hedge funds taking massive bets – they could go from minus 30% to plus 30%, the range is very large and you’ve got to be careful of that,” he adds.

• Bargain Hunter: ‘safe-haven’ trust is cheap and discount risk limited
• Jeff Prestridge: how to keep growing your personal wealth

A question of cost

Aside from their complexity, another issue that could make absolute return funds less appealing to retail investors is their cost. Many have high charges (OCF – ongoing charges figure) and some still carry performance fees of as much as 20%.

This is “hard to justify when the whole industry is being driven towards lower and more transparent pricing”, says Cole. He explains that some funds are now looking at different, more realistic pricing structures. One he is currently looking at is Artemis Targeted Return Bond, which has a clearly defined strategy, an OCF of 0.4% and no performance fee.

What can replace absolute return funds in portfolios?

While the one-stop shop of an absolute return fund may hold a certain appeal for retail investors, there are other ways to achieve a similar effect in portfolios.

“A lot of investors go to absolute return funds when they’re feeling a bit paralysed from where the markets are,” says Rush. “They don’t want to go into equities because it’s too much risk, they don’t want to go into bonds because, while they are supposed to be safe, there are periods where bonds fall. And they don’t want to go in to cash because, if inflation comes back, you’ll get carried out. But they’re not the only answers and I don’t think you have to look for a one-stop shop, you can hold a blend of things.”

• Top 10 most-popular investment trusts: November 2020
• Take control of your retirement planning with our award-winning, low-cost Self-Invested Personal Pension (SIPP)

One solution is simply to hold more cash in times of market stress, Rush suggests. You can also use short-duration corporate bond funds or, if you’re looking for the low correlation to other assets that absolute return funds are supposed to give you, you could look to alternative assets, says Cole.

Ultimately, “there’s no one-size-fits-all as to what fills that void,” says Cole, but careful asset allocation can protect portfolios if investors would rather not risk the disappointment of a costly and complicated absolute return fund that fails to do what it says on the tin.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.