In conversation with: Himanshu Chaturvedi, Brendan Walsh, Simon Hill and Sebastian Cheek
How have absolute return strategies performed given the current macro environment and market
conditions? How should we be judging this performance?
Brendan Walsh: You have to be careful when talking about absolute return; I tend to think there are at least two different approaches. The first we call target return, where you are looking to deliver a cash (or inflation) plus target with low volatility, so trying to achieve that return with minimal risk. The other is the more classic hedge fund strategy looking to maximise return, given a risk budget you would expect the latter to be quite volatile particularly in this sort of environment.
Over the last two years some of the macro funds have struggled as co-ordinated central bank policy gives way to a somewhat multi speed world. Of course some of the target return funds have struggled as well – DGFs have been challenged as correlations have become more unstable. Having said that we have seen that its possible to deliver a cash plus return of over 6% thought this period if you pay attention to portfolio construction and take a longer term view.
Simon Hill: Judging absolute return means different things in growth assets as compared to bond type portfolios, and there are many different approaches. An absolute return fund should have generated a positive return last year. And though conditions were difficult, they weren’t that unusual. I think they should be judged in terms of generating a positive return relative to cash. Of course, cash has been a peculiar benchmark for eight years now in itself.
We would not think about DGFs in the same way and would expect them to have done poorly in the circumstances we had in August/September last year or early this year, though we would expect them to fall less than 100% equity funds.
Himanshu Chaturvedi: There is no standard way of generating absolute return, so you should expect a wide dispersion between various funds. There have been only three or four occasions to really test the absolute return space in any meaningful way over the last few years. These periods serve as a good reminder of what these strategies do and – the clue is in the name – they should generate positive return to some extent across-market environments. As investors, we must continue to be discerning, understand these strategies because it is not an asset class for which you can easily say what you will get.
Walsh: In the same way that balance funds became DGFs became multi asset funds; a lot of those multi asset funds are now absolute return funds and are not doing anything particularly different from what a balanced fund used to do. Having a 60:40 equity/bond portfolio has delivered a reasonable absolute return over the last 15 years, but we think it will struggle to do so on a prospect basis over the next 15. One of the reasons is you are not getting that almost free protection from having a bond allocation. As an example, developed market bonds over the next five years in some cases price a negative expected capital return. A targeted absolute return fund though includes in it some concept of almost entirely eliminating the downside, but the critical issue is over what time period? A day, month, year? Five years? 10 years?
Hill: Funds defined as absolute return can get tempted away from that principle in conditions where growth assets are growing strongly. That would be concerning and it is no comfort to us to hear a manager of an absolute return product say they were caught long when equity markets go down – they shouldn’t be there. It is key whether people are trying to do timing of risk, pursuing a highly diversified approach, or taking beta out entirely and using a really solid long-short strategy to get bits of alpha round the edges for a small return.
The last 12 months was a key test because it ended up roughly flat in capital terms for most asset classes with no real help from interest rates or yields. You couldn’t just get by with a cash return but you had quite a lot of volatility along the way in a number of asset classes that will have helped sort the sheep from the goats; and pursuing additional yield wasn’t a good strategy last year because high yield blew out and so on and so forth.
Walsh: As a portfolio manager, I always want something in there that will do well when risk assets are doing badly. And if you take that as a starting point it is easier not to get swayed by becoming too directional; because you are always looking for offsets and asking the question what happens if I am wrong, what happens if nothing happens. So you are always conditioned to have something in the portfolio that performs when your central view is not really working, or is challenged by the market, and the key thing here is it should not cost very much money in your central view of the world. August and September last year and the start of this year are great examples of when this is useful. If you are trying to split the portfolio between longer term themes and tactically hedge, ie a strategic part and a short term piece, you are having to do tactical and strategic and I think in this sort of fast paced environment where the volatility is high, it is really easy to get sucked in to the tactical piece basically overwhelming your whole portfolio; and that is where you can sometimes see large drawdowns or unexpected volatility. It’s one reason why we only concentrate on the three to five year horizon and don’t try and exploit tactical opportunites.
