Holden & Partners Quarterly Investment Views: Q2 2019 Outlook
It is worth highlighting that ‘absolute return’ as a sector is a somewhat disparate collection of strategies, not all of which are directly comparable. In its simplest form, funds with an ‘absolute return’ mandate aim to achieve positive investment returns irrespective of the prevailing market conditions, typically whilst targeting lower levels of volatility than traditional risk assets.
While this is not guaranteed – absolute return funds can, and indeed do, fall in value at times – such a target is attractive when allocating to alternative asset classes that may provide protection in the event of an equity market correction. We do not attempt to time market downturns but are cognisant of the fact that risks to the downside have increased. Portfolio resilience, and broad diversification amongst asset classes, is therefore critical given such a backdrop.
Absolute return strategies have specific attractions when compared to other alternative options, many of which do not possess such an overriding emphasis on consistently growing value. The first of these is that they have their own distinct behavioural profile and are not unduly influenced by events in other asset markets. Incorporating absolute return as part of an investment portfolio, therefore, has positive effects, principally by broadening the level of diversification whilst controlling overall volatility.
Another, perhaps more pertinent, feature is the flexibility that managers within the absolute return sector possess, and the variety of strategies employed in order to achieve their mandates. Market neutral, long/short, multi-asset and fund-of-funds products are a few of those available to investors, each with a differing risk/return profile.
Market neutral strategies involves a fund manager purchasing, or going ‘long’, those shares they deem likely to appreciate in value, and selling, or going ‘short’, those shares they deem likely to depreciate in value, in equal measure. This equalisation removes – or ‘neutralises’ – the impact of the overall market movement on the portfolio, such that the manager is indifferent as to whether it moves up or down; instead, the fund’s return is influenced solely by the accuracy of the manager’s views on the shares that were either bought long or sold short. These products differ from directional long/short funds, in that they possess neither a net long or net short position, and therefore have a far lower correlation to risk assets and less volatile return profiles.
Multi-asset strategies typically base their investment process on an assessment of the global economy and then combine the search for relative value between asset classes with diversification amongst markets, strategies, and investment horizons. Some funds will group assets into different classifications – risk-mitigating or diversifying, for example – and alter the split between them depending on the market environment. The Investec Diversified Income fund is an example of a multi-asset absolute return fund with strong downside protection characteristics. The fund’s multi-faceted approach is bolstered by the fact it utilises asset class specialists from across the firm, as opposed to a pure reliance on the input of one portfolio manager. The fund’s objective is also relatively unique in the space, as it aims to generate a large proportion of its return from income as opposed to capital growth, thereby decreasing downside volatility in comparison to its peers.
There is, of course, no magic formula for guaranteeing positive returns and the use of absolute return funds should be seen in the context of a diversified portfolio depending on the risk mandate sought. We remain advocates of apportioning a percentage of our lower risk portfolios to select absolute return funds. The focus on consistently growing value, investment flexibility, and diversification benefits continues to be attractive for cautious to balanced investors.
That being said, we recognise that some strategies have outperformed others, specifically those with lower volatility targets and a multi-asset approach. We have not lost sight of the fact that the purpose of such funds is to reduce the overall volatility of a portfolio and not to outperform traditional asset classes, such as equities. With this in mind, we will be reducing our overweight to absolute return gradually over the coming months to reflect a more neutral stance, while increasing selective defensively-positioned fixed income holdings.
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