• Marie du Plessis

Funds that weather the financial market storm

Absolute Return Funds essentially aim to make a positive return for investors in other words to make money over pre-defined time horizons (such as 1 or 3 years). Typically, they target an inflation-beating return with a dual aim of also preserving capital. Their success, however, depends on their ability to deliver on their aims regardless of the underlying investment market conditions e.g. a market downturn.

Absolute Return Funds are frequently compared to traditional Balanced funds, however there are important differences between them:

  • Absolute Return Funds usually offer more scope to take extreme asset allocation positions that enable capital preservation, whereas Balanced Funds have a more predictable and constrained asset allocation.

  • Absolute Return Funds usually attempt to protect capital over shorter time periods (e.g rolling 12 months) while Balanced Funds usually don’t have such capital protection objectives. This means that Absolute Return Funds frequently employ protective derivative structures.

  • Absolute Return Funds generally tend to underperform Balanced Funds in bull markets, due to their less “market-directional” strategies, and vice versa. The best Absolute Return Funds are however able to capture high “upside participation” while also experiencing low drawdowns.

When are Absolute Return Funds meant to “shine”?

South African (SA) risk assets struggled during 2018, with SA equity markets down 8.5%, while the poorest performer being the listed property sector shed a staggering 25% of its value in the calendar year. Positive performance was generated predominantly by fixed income assets and offshore assets, which were cushioned by the weakening of the Rand. The only multi-asset ASISA category that managed to deliver positive returns (on average) was the Low Equity category, but this was attributable mainly to the maximum equity constraints applicable within this category.

In years such as 2018, risk management is imperative. As American billionaire investor Seth Klarman stated, “Investors should always keep in mind that the most important metric is not the returns achieved but the returns weighed against the risks incurred. Ultimately, nothing should be more important to investors than the ability to sleep soundly at night.”

Risk, within an asset class, is usually defined as absolute volatility or tracking error against a benchmark (relative risk). 2018 however demonstrated that it is the risk of permanent capital loss that needs to be managed carefully, as it is the element that is most likely to keep one awake at night.

Despite the market turmoil, Absolute Return Funds were well equipped to weather the 2018 financial market storm. With the primary objective for such funds being risk management and protecting capital in down markets, they were ideally positioned to shine in adverse market conditions. Long-term returns and outperformance are generated largely as a result of the protection against significant short term losses.

The performance

While equity markets did show some recovery over the first two months of 2019, Absolute Return Funds were able to both protect capital during the 2018 downturn, as well as capture upside during the short-term market recovery in 2019. The graphs below, showing the 1 and 3 year returns (to 28 February 2019) of a selection of popular Absolute Return Funds, bear testimony to the robustness of these strategies.