Absolute return fixed income is chiefly on the mind of the four panellists. In expectation of the end of a 30-year bond bull run, Goldman Sachs launched an unconstrained bond fund – but one without credit, mostly consisting of currency and EM. “All unconstrained bond funds verge on the side of liquid alternatives,” explains Nick Philips (pictured right), head of third-party distribution, EMEA and Asia ex-Japan for Goldman Sachs AM. “This fund is a more liquid version of one of our hedge funds and the people buying it are more hedge fund-aware than most.”
Even though investors might be more hedge aware, there is still confusion in the market. “I think the problem is the definition of absolute return,” explains Massimo Greco (pictured left), head of European fund distribution for JP Morgan AM. “The way we look at it is that ‘absolute’ means capital preservation over a reasonable period of time. That requires managing risk very carefully – and not taking advantage of certain opportunities if the risk profile is not right. I don’t know how many of those buyers who say they want to buy absolute return end up instead with more aggressive fixed income allocation funds.”
“We have a large fund in this space,” says Philips. “The Strategic Income Fund is put into the bond part of a portfolio or the alternatives part, depending on how you view the product. It falls in both camps.” I ask him which bucket he thinks clients ought to put the fund. “I don’t mind which category they put it in,” he says. Greco chimes in: “An absolute return fund makes sense for two types of clients: firstly, as part of a broader portfolio for diversification and risk reduction: volatility dampening. Secondly, it makes sense for those investors who hate losing money on bonds.
“Even though our fund over the past year has not had the best performance – as you can imagine, it’s been a tough year – it is still appreciated by advisers who are afraid of having a conversation with clients about bond funds being down. The important thing is that clients have to understand the trade off.”
“We also have one of these,” says Greg Jones, head of retail, EMEA and Lat Am, Henderson Investors. “We have an absolute return credit fund called Credit Alpha – it has no duration and makes money from pairs trading. It has an eight year track record. We soft closed at $1.2bn – total capacity maybe $1.5bn. It also had a difficult time last year – it was flat, when most investment grade credit funds made maybe 2% to 5%. But it serves a purpose, which is that gives more than cash – it often fits in the liquid alternatives space.
“We took a view a while ago – we became very concerned about the use of the word ‘absolute’ and what it meant to investors. Rather than taking a three-year rolling cycle, our view is that if it’s going to have the word ‘absolute’ in it, we need to concentrate on a 12 month basis.
Hedge strategies wane
But not everyone in the room has the same perception of the unstoppable rise of absolute return funds. Stef Bogaars, head of Europe, Investec Asset Management, thinks that there is trend in the mainstream away from hedge strategies.
“From an investor point of view I see decreasing demand – especially on the institutional and private banking side – for hedge funds and absolute return,” he remarks. He mentions that CalPERS has recently completely dropped all exposure to hedge strategies.
“We used to run emerging markets hedge fund strategies – but they virtually closed down over time,” he says. “Same goes for the commodity business. It’s not about cost of AIFMD but investor demand. There have been multiple years of bad performance – Alan Howard of Brevan Howard had his first year of negative performance. If funds like Brevan Howard and Paulson have a bad year, the sector could lose momentum.”
Southern Europe leads the way
However, so far the momentum has sustained, especially in certain regions. According to the latest Expert Investor Europe data, the biggest buyers of absolute return are the Italians, Spanish and Portuguese. This marries up to Jones’s experience. “We’ve had massive flows from Spain and Italy into absolute returns – especially in equity long/short,” he says. “It’s for people who want to dip their toe into equities but with something that feels market neutral but does have some beta exposure.”
A rather surprising success has been Henderson’s UK equity market -neutral fund which has been selling strongly in Italy.
“When we first showcased that to the Italians, our head of sales in Italy said ‘There’s no way we can sell something that has got UK absolute return written on the tin’. But the reality is that investors buy a risk/return profile. It is market neutral, so it doesn’t matter where it invests. We sold about £700m (€962m) last year in continental Europe.”
The long or the short way?
“But over the long term, can you really please investors with long/short strategies?” counters Bogaars. “I think it will be a rocky ride. Do we really believe that in five years’ time there will be more AUM in long/short strategies than today? “Simplicity is your friend. Markets and regulators are all working towards simpler strategies. Anything too technical is hard to explain to the client – and the regulator.”
“I don’t believe the regulator is the problem,” disagrees Greco. He thinks that within the Ucits framework, there are enough regulators with experience of these products to allow them through. The issue is elsewhere. “Where we have to be very careful is from a fiduciary point of view. How do we market these things? Some of these products should only exist in institutional share classes.”
He goes on to stress that it’s important to find the right investor for your fund – especially if you want to avoid hot money. “This is especially when you have a fund with issues of capacity: you might as well sell them to somebody who buys the story and is in for the ride and accepts some of the volatility. That’s why the portfolio construction element is so important,” says Philips. “Investors have to understand why they are buying it.”
Do fund managers find themselves having to sell portfolio construction tools along with selling funds?
“We have a staff of seven or eight people in London who do that for a living,” answers Greco. “They are called the product strategy group but most of their time is spent in explaining how funds fit in a broader portfolio.”
“It’s the same for us,” says Philips. “Of course clients do their own portfolio construction, their own asset allocation. But sometimes they will give us their entire portfolio and we’ll run it through our risk team. We’re not giving them advice, we’re just telling them what could happen.”
So, getting out our crystal balls, what are the trends and opportunities going to be going forward?
“For our investors, especially on the retail side, in order to get a bit more juice out of the portfolios, we have to accept that people have to take more risk,” says Bogaars. “Unfortunately for retail investors it’s very difficult to go into illiquid investments like senior bank loans or real estate. So one of the solutions is to go more into equity income. I believe as well that the change from developed to emerging markets where EM is relatively better priced I think is important. I would also say taking more low-volatility equity risk is something I believe in.”
Meanwhile Philips agrees that the search for income will continue, whether it’s through fixed income,
equities or covered calls. “The demand and the growth for liquid alternatives is going to grow because people need absolute return – people are looking for that 3% or 4% pa,” he says. “And as for developed versus emerging, if you have an emerging market product that can select the right country, you could get very strong returns.”
Jones considers the credit market. Because his view is that rates will remain low for a long time, yield will remain hard to achieve. However, as long as economic conditions don’t deteriorate too much, default rates will remain low and so in the high-yield end of the market, there is still value.
“On the equity side, look at the developed markets,” he says. “We just bought a small/mid-cap quality
growth business in the US, called Geneva Capital Management. It’s had a tough couple of years: if you look at quality growth in that time, cyclical, low-quality growth stocks have done very well. Quality growth stocks have underperformed. “Our bet is that it’s the right time of the cycle. We think you could get into a nifty-50 type situation, where some growth stocks outperform. The P/E is already at a premium but we think that it could expand significantly over the next year or year and a half.
“Another theme I believe in is dividends. We run an index called the Henderson Global Dividend Index.” This records the dividend behaviour of the biggest 1,200 companies in the world every quarter. It has more than 10 years of data. “The idea is to get everyone – from pension funds to end investors – to think about it.”
Greco has a different, though related focus: income. “Income should be the primary objective and mandates should be managed with that in mind. You set the level of income you are looking for, and that by and large determines the risk you have to take in the portfolio – and
you try to manage that risk efficiently.”
So where are the other opportunies? “I’d like to talk about Africa,” chimes in Bogaars. “The problem with Africa is capacity,” notes Greco. “Of course, capacity is limited,” Bogaars replies. “If you are going to raise $2bn in private equity you can buy in but there is no exit. It’s a 20-year trend.”
“Is it a 20-year trend, though?” asks Jones. “Or is it a frontier market play because there’s so much
money circulating around the system…”
“No, no, no, I’m talking about favourable demographics leading to returns,” insists Bogaars. “Is there
capacity? No. But will there be in 20 years? Yes!”
Finally our panellists are asked what product that they don’t have they would like to launch if they could do it immediately. “I would leverage our hedge fund pedigree and launch a global equity
long/short,” says Philips without hesitation. “I have to say exactly the same here,” says Jones.
“For me, it’s hard because we have such a big range,” says Greco. “But I’d like to have more equity long/short products.”
“I would like to have a quantitative global macro fund,” says Bogaars. What is interesting to note is that all four answers come from the universe of hedge strategies, which makes it look like the trend towards alternatives isn’t over quite yet…