A quick look at the IMA Absolute Return fund sector shows that 20 of 38 funds have lost money over the year to date (at the time of writing). What’s going wrong?.
While it’s harsh to judge funds on short term performance, it’s nevertheless pretty shocking when you consider the aim of these funds is to make money regardless of whether markets go up or down.
Why have the majority of absolute return funds lost money during the recent market falls and very recent recovery?
The simple answer is that the judgement of quite a few managers appears to have been off, i.e. their bets on sectors and/or stocks rising or falling didn’t pay off.
We’ll look at a few popular funds to try and work out what’s gone wrong, but first a quick recap on how these types of funds work.
Most absolute return funds use a long/short strategy, which means they can profit from bets on both rising (long) and falling (short) markets – read the hedge funds section on our specialist investments page for more details.
The relative balance between a manager’s long and short bets is pretty fundamental, as it will largely determine whether their overall position will benefit from rising or falling markets. Of course, it’s more complicated than that, as they might bet on specific stocks/sectors to buck the general market trend or ‘pair’ stocks in the same sector to try and remove market risk (see the market neutral explanation in our hedge fund section), but in general terms a net long fund will lose money in falling markets while a net short fund will make money.
You can find out a fund’s long/short position by looking at the fund manager’s factsheet. For example, a fund might be +140% long and -60% short, giving a net long exposure of 80%. This means for every £100 invested the manager has shorted £60 of shares (giving them an extra £60 to invest) and bought £140 of shares, which leaves £20 in cash. In simple terms a net long exposure of 80% means if markets fell by 10% you’d expect to make a 8% loss (although if the manager chose their stocks/sectors well you might lose a lot less or even profit).
The returns and net market exposures for some popular Absolute return funds have been:
| Fund | Return Year to Date | Net market exposure on 31 May 2010* |
|---|---|---|
| CF Octopus Absolute UK Equity | -17.9% | +80% |
| Cazenove UK Absolute Target | -4.1% | +31% |
| Gartmore European Absolute Return | -2.9% | +20% |
| Blackrock UK Absolute Alpha | -1.5% | +20% |
| Jupiter Absolute Return | +0.3% | -20% |
| * from latest available fund factsheet. | ||
The FTSE All Share Index returned about -0.2% over the period, so it seems some of the above managers must have made some bad sector and/or stock bets. The CF Octopus Absolute UK Equity fund had a high long exposure to BP, which obviously hasn’t helped. With the others it’s harder to spot, especially as their net long exposure is quite low. But looking through the fund data suggests Cazenove has lost money this year via its software and energy exposure while some of Blackrock’s ‘paired’ trades have lost money.
Overall I think it’s still too soon to judge many of these funds, but it’s vital you understand what you’re buying. Absolute return is a great concept, but you’re especially reliant on a fund manager’s judgement for success. Not only must they be good stockpickers (history suggests the majority of conventional fund managers aren’t) but they must also be good at anticipating market movements – a tall order!
Before investing check a fund’s net market exposure to get a feel for how exposed you might be to market movements and look at the manager’s track record to see whether they have any previous success running this type of fund.
Finally, there are other types of absolute return fund. Some invest in corporate bonds (along similar lines to long/short funds) while others invest in a wide mix of different assets. The latter makes sense if you want a one-stop fund, but less so if you already have a well diversified portfolio.
If you want to bet on falling stockmarkets yourself you can do so using an exchange traded fund (ETF) that shorts the market or via spread betting (but beware, this has its own set of risks).
Read this article at http://www.candidmoney.com/articles/article128.aspx
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