Greetings! This week I’ll share some research that will hopefully help you or a loved-one understand if you are invested in something that may work out well, or that may be worth getting out of. We look at Absolute Return Funds from Mercer, Standard Life, Zurich Life and New Ireland. Absolute Return Funds have received a lot of negative press in recent years, we’ll see if it is still justified or not.

The number of people I come across that hold significant chunks of ‘Absolute Return Funds’ in their pension or investment portfolio is surprising, to me. It is surprising on the basis that these funds have generally not delivered on their promise for many years. At least that was true to say when we last reviewed them, in Blog 133 at January 2020. You can read that piece here.

But of course, January 2020 was just before one of the most vicious and sudden temporary market declines we have experienced in recent decades. And given the fact that Absolute Return Funds exist “to provide positive investment returns in all market conditions over the medium to long term” (Standard Life), surely the declines of H1 2020 were a perfect time for them to shine. Surely, over the course of 2020 they justified their existence and proven all the nay-sayers wrong. Surely? Let’s see.

And for the record; if Absolute Return Funds do deliver what they are meant to deliver then I’d be delighted. I have never used them and have no plans to use them, but likewise I don’t wish them ill, in fact the opposite it true. Reason being, there are tens of millions (if not hundred of millions) of Irish Retail Investor money in them, so lets hope they have turned good since our last analysis in early 2020…

Jan 2020 Analysis – A Summary

As of January 2020, here are the headlines from Blog 133:

• Absolute Return Funds have been around for about 10 years, developed by companies in order to try re-convince people to buy their investment products following the significant temporary market declines of 2008-2010
• The reason they became so popular was they were driven hard by advisors, and they were sold on the basis that they would help you achieve equity-like return but without equity-like volatility; which we know is fundamentally impossible, but nonetheless that’s why Absolute Return Funds exist!
• They had expectations of delivering ‘Cash +3%’ and some (such as Standard Life’s version) even said they’d deliver ‘Cash +5%’ growth over rolling 3 year periods. On that basis it was no surprise they were popular
• Instead of taking a standard ‘Multi-Asset’ approach to the portfolio, Absolute Return Funds pursue complex investment techniques such as Derivatives, in an Actively Managed manner
• Typical Volatility Ratings of 5 (where a pure Equity Index may be c.15 and a Bond Index c.3)
• One such example we came across stated the fund invested in a number of “relative value strategies”, including a “Swedish flattener v Canadian steepener”, while its “directional strategies” include “Long INR v CHF”. (INR is the Indian rupee and CHF is the Swiss franc)
• As a result of the Active Manager approach, the costs of ownership tend to be higher than other investment options
• By and large, the performance of Absolute Return Funds was far below the expectation
• If you had €100k invested in May 2016 in 6 of the main Absolute Return Funds in Ireland, by Jan 2020 your fund was worth less than €101k in 5 of the 6 funds. Only Mercer’s did any better In real terms
• That was a narrow window of time but in the majority of cases, you lost money in real terms
• Absolute Return Funds did not do what they were meant to do in that timeframe (we went to 2016 because that was when many of these things started)

May 2021 Analysis – A New Phase for Absolute Return Funds, or More Of The Same?

If ever there was a time for Absolute Return Funds to prove their mettle, it was 2020 right? An unprecedented rapid decline in Markets in March 2020, a mixed bag of performance across multiple asset types, and general mass hysteria. A perfect environment for Absolute Return Funds to, as they said, “provide positive investment returns in all market conditions over the medium to long term”.

Much like we spoke about last week when looking at Berkshire’s performance over various time-lines (read about that here in Blog 173), we will review Absolute Return Funds in the same way, multiple time-lines.

Quarter 1 2020:

Focusing on the eye of the storm which was Q1 2020, we would expect Absolute Return Funds to remain more buoyant than Equity during the massive market meltdown (The 3 M’s!). From the graph below in this Blog 175, you can see how the main 5 Absolute Return Funds did perform in that period:

So, while the likes of Vanguard Global Equity Index fell by almost 30% in that period, the worst performing ARF (Absolute Return Fund, not Approved Retirement Fund!!) fell by a max of 15%, finishing the quarter 10.8% down. The rest of them finished between 0.8% and 5% down for the quarter. As noted earlier, they are not without risk of loss of invested capital, and this was clearly displayed in Quarter 1 2020.

Quarter 2 2020:

So, what about ARF performance during the ‘bounce-back’ that was experienced by Equity Markets during Quarter 2 of 2020. Once the world recovered from the initial shock of Q1, we saw equity markets recover across the globe, did the Absolute Return Funds benefit from the rising tide also? Well credit where credit is due, the majority did see some recovery in Quarter 2!

Mercer, who were the worst hit by the Q1 declines were, not surprisingly, the bigger beneficiary of the subsequent recovery, recouping a fairly modest 7.8% in Quarter 2. The rest achieved between +4.8% and -1% in Quarter 2.

The lie-of-the-land for H1 of 2020 was therefore that all of the 5 Absolute Return Funds we assessing here had negative returns ranging from -0.4% to -3.9%. All in negative territory.

For context, a Global Equity index was at -5.7% for the half, and a Global Bond index was at +3% for the half. What is interesting about that is, on a risk-adjusted basis, the ARFs were rubbish – they carry more volatility than a Bond Index yet they delivered negative returns during a 6 month period where the Bond Index was 3% positive. It is a narrow window of time of course, Jan 2020 to July 2020, but telling none-the-less.

From Start of 2020 To Today…Absolute Return Funds

Stepping back and looking at things over the past 17 months, January 2020 when we wrote Blog 133, to today. How have Absolute return Funds performed over that period of bust and then boom.

In that 17 month period there has been a wide variance of returns based on the data inputs we have used here. Mercer’s fund delivering 6% return, Standard Life 4%, New Ireland’s BNY Fund 2.5% and Zurich’s Invesco Fund -5.4%. A spread of over 11% across just these 5 funds over that period. If you held the four funds as a portfolio with an equal weighting in each fund, you’d be sitting on a +2.25% return for the 18 months, which is not bad at all to be fair!

Also interesting is that a Global Equity Index which fell by 30% in H1 2020 has recovered and stands at +17% on it’s valuation at January 2020, while the Global Bond Index (in this case Vanguard) dipped and stands now at 1.5% over that same period, which again is still a short period of time to try make any conclusions.

From 2014 to Today?

In the interest of retaining the long term perspective, we go back as far as we can with the funds in question, which is to December 2014.

When we see this graph (Blog 175), we are again given the perspective we should hold when investing for the long term. And while 6.5 years is not long term, it is longer than 18months!

The ‘Long Term’ results:

• Global Stock Index (Vanguard) +96% (Volatility Rating 16.8)
• Mercer Absolute Return +27% (Volatility 7.9)
• Global Bond Index (Vanguard) +11% (Volatility 3)
• Standard Life GAR Strategy Series 2 +4.9% (Volatility 4.8)
• New Ireland BNY Mellon Absolute Return Bond +2.07% (Volatility 4)
• Zurich Invesco Targeted Return -2.4% (Volatility 3)

So What, Are Absolute Return Funds Of Value?

There are three primary conclusions that the above results will point towards, in my view:

a) For it’s level of volatility, the Global Bond Fund has delivered really quite well

b) For their level of volatility, most ARFs have delivered really quite poorly

c) For it’s level of volatility, the Global Equity Index has simply crushed everything else

There is a term in the investing world that refers to an investor getting the returns they deserve based on the level of volatility they take when investing in different assets or portfolios; Risk Premium (which should be Volatility Premium if you ask me). It does seem based on the data above that Equity and Bonds continue to offer a suitable level of Premium (Returns) based on the level of RISK (Volatility), there is a correlation between risk and reward so-to-speak. The same however cannot be said of Absolute Return Funds – and hence one still cannot say with any degree of fact that Absolute Returns Funds are delivering equity-like returns without equity-like volatility, not even close I’m afraid.

Paddy