Many popular absolute return funds targeting low volatility are in danger of registering annual losses. What can managers do to turn around performance?
Absolute return funds targeting low volatility have endured a tough time so far in 2014, as volatility indices fall to record lows.
Over the past 18 months, the popularity of the strategies has helped them see strong inflows, with a number now soft- or hard-closed, including the £1.6bn BNY Mellon Absolute Return Equity, £1.1bn Insight Absolute Insight Equity Market Neutral and £400m Schroder Absolute UK Dynamic funds.
However, while inflows have been strong, record low levels of volatility are hindering the strategies year to date, with many set to register annual losses unless performance turns around.
Data produced for Investment Week by Whitechurch Securities shows the majority of funds which aim to deliver returns with lower volatility than the market have failed to grind out positive returns so far in 2014 (see table below)
For example, the BNY Mellon and Insight funds are down 0.2% and 0.1% year to 17 June, respectively, and have only managed a meagre 2% and 1% over the year, versus a FTSE All Share index return of 12%. Schroders’ fund has fallen 4.6% year to date and is down 1.2% over one year.
Asset class correlation
So what is hampering the strategies? Fund buyers said the increasing correlation between many risk assets has impacted them, with the various strategies each fund pursues currently moving in tandem rather than providing diversification.
Ben Willis (pictured), head of research at Whitechurch Securities, said with volatility indices hovering at the lowest levels since before the financial crisis, the funds are struggling.
Willis said: “What these funds need is a bigger steer on which direction the market is moving so they can make sector bets, but at the moment there is high correlation between stocks and asset classes, and low volatility.”
Can funds bounce back?
A number of investors are wary over the outlook for the funds, especially as their strategies do not lend themselves to taking big bets to reverse the current year-to-date losses over the next six months.
James Calder, research director at City Asset Management, said: “There is a strong argument for doing this with a long-only manager, but it is different for long/short managers. The losses really hurt them, and the concern now is, if a manager has had a few bad months, will he put risk back on the table?”
Ben Yearsley, head of investment research at Charles Stanley Direct, said: “Most of these funds look to make 3%-4% a year from trading strategies and a bit more from the cash, so it would be reasonable to expect an annual return of 6%-7%. But with no cash returns coming at all at the moment, you are looking at just trading and, in a year like this, when there has not been a huge amount of volatility, it is very tough.”
However, Willis is not in a rush to sell his holdings, saying the dip is cyclical and these products should be viewed on a three-year basis, with some of their objectives promising a positive return over a 36-month cycle.
“As long as the fund is doing exactly what you expect it to, stick with it, because these funds should not fall considerably,” Willis said.
“We have asked our market neutral managers to explain the underperformance, but we would only worry if they have completely changed their tack.”
More flexible options
Both Calder and Yearsley, however, are going for more flexible long/short strategies, which allow managers to vary their long and short positions instead of keeping a neutral stance.
One of Calder’s top picks is the £293m Old Mutual UK Dynamic Equity fund managed by Luke Kerr, which is currently nearly fully invested on the long side, despite being a long/short strategy.
Yearsley holds SLI’s GARS and is considering taking a position in Luke Newman’s Henderson UK Absolute Return, which has made 9.5% over one year.
Performance of absolute return market neutral/low volatility funds
Months of negotiations
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