Managers of absolute return funds only welcomed a net aggregate sum of €299m in November. This is down from a 2015 monthly inflows average of almost €7bn. Appetite for asset classes of course comes and goes, driven by market sentiment. European equity fund flows have been the most prominent example of that in recent years.
Demand for absolute return funds, however, ought not to be dependent on market sentiment, as these funds promise to deliver ‘absolute returns in all market conditions’. Their problem is that they haven’t quite lived up to this promise. Expert Investor already signalled more than a year ago that multi-strategy funds had stopped generating returns for their investors. In 2016, they were joined by the second-biggest absolute return category: long/short equity funds.
Funds in the Morningstar Multistrategy category generated an average return of -0.11% in 2016. Over a three year-period, things hardly look better with an annualised return of 1.06%. Though monthly inflows into the category have declined somewhat, they remain comnfortably above the €1bn mark. Fund buyer appetite also remains strong across most of Europe. Switzerland and Belgium are the only two countries where investors seem to have lost faith in multi-strategy funds, as of yet…
Standard Life Investments’ flagship fund GARS, the largest absolute return fund, is the best example of the increasingly sclerotic state the asset class is finding itself in. Until about two years ago, it had been the absolute frontrunner as a pioneer in the absolute return space, delivering strong returns with minimal volatility with minimal beta correlation. In November 2015, when performance was already on the wane, the fund still saw net inflows amounting to €1bn in just one month. In 2016, however, disappointed investors have started pulling money from the fund:
The long and short of a crisis
Long/short equity funds had an even worse year than multi-strategy: the average European long/short equity fund made a return of -1.59% in 2016, according to Morningstar data, and less than 17% of those funds managed to outperform the MSCI Europe benchmark.
And investors are showing their concerns about these funds by voting with their feet: since June, six consecutive months of net outflows have been recorded, with November seeing the largest redemptions from the category since February 2007.
Expert Investor has tried to shine some light on the question why absolute return funds have delivered such disappointing returns of late. As I argue in this article published in October last year, it’s probably fund selectors themselves to blame. They see absolute return funds first and foremost as a fixed income replacement rather than as an alternative source of return. Consequently, most money flows into low-vol funds that prioritise delivering stability at the expense of returns.
The Argonaut saga
Should absolute return managers therefore take more risk in order to deliver alpha for their investors? That’s what Barry Norris, manager of the Argonaut Absolute Return fund, advocates. He believes absolute return managers are only worth their fees if they outperform the market while ensuring their portfolios remain largely uncorrelated. Norris largely succeeded in this aim for several consecutive years.
But then came 2016, when Norris reminded his investors that stock-specific risk can be far greater than beta risk: almost all of his long and short bets backfired last year, resulting in his fund losing more than a quarter of its value and finishing the year as the worst performing of all Ucits funds.
Perhaps it’s therefore not a bad idea to prioritise volatility management, as failing to do so can wipe out many years of previous returns. Funds that fail to deliver returns to clients, however, will face existential problems, even if they do so with an admirably low volatility.