'I’m waiting for the next crisis to deliver my absolute returns', says manager of BROOKS MACDONALD DEFENSIVE CAPITAL
'Nervous': Jon Gumpel believes that markets will fall
Funds that strive to generate positive returns for investors through thick and thin remain popular. The latest figures from the Investment Association show that last year, targeted ‘absolute return’ funds were by far the favourite sector.
British investors made net purchases of £5billion in the sector during 2016 – double that of its nearest rival, global funds.
As their name implies, absolute return funds aim to produce a positive return which is better than that available from cash.
They do this by investing in a range of assets, including financial instruments that either provide protection when stock markets slide or make money from falling equity prices. Though there are 98 funds in the sector, no two are the same. Investment styles vary widely, as do the benchmarks they aim to beat.
Indeed, analysis by multi-manager Wellian Investment Solutions indicates that 20 of the funds that fall into the targeted absolute return sector have no explicit benchmark, making it hard for investors to understand what they are trying to achieve.
One fund that has served investors well is Defensive Capital, managed by investment house Brooks Macdonald. Its aim is to deliver absolute returns over every rolling three-year period. Over the past three years, it has generated a return of 33 per cent.
Manager Jon Gumpel says his mantra is ‘not to over-promise while seeking all the time not to under-perform’. The fund is spread across key asset classes including bonds, convertible bonds, preference shares and undervalued investment trusts.
But the largest holding is in structured products and, in particular, ‘autocallable’ plans offered by the world’s biggest investment banks – the likes of Barclays, Credit Suisse, Goldman Sachs and JP Morgan. Typically, these provide a predetermined annual return, but only pay out if the chosen stock market index has exceeded a set level on a set date.
The fund is spread across key asset classes including bonds, convertible bonds, preference shares and undervalued investment trusts
If this is achieved in year one, the product is unwound and the investor gets a year of return. If it does not happen until year two, they get two years of return. If it does not happen at all, and the autocall matures, investors lose part of their capital based on the index’s fall over the term – and receive none of the annual return.
So far, Gumpel has picked his autocalls shrewdly and has made healthy profits by taking positions in investment trusts or firms where the assets are not reflected in the share price. He has then profited as the share price has risen to better reflect the firms’ worth.
A stake in AIM-listed Burford Capital, a provider of finance to the legal profession, was bought when its shares were between 120p and 130p. Gumpel sold out at 320p and, though the share price is now above 700p, he is happy to have banked the profit.
Gumpel is nervous about where stock markets are heading, especially if interest rates start to rise. As a result, he has bought a number of options that will deliver positive returns if markets fall.
‘I am waiting for the next financial crisis,’ he says.
Anna Lane, head of consumer investment company The Wisdom Council, says targeted absolute return funds have huge appeal. But she cautions that investors must be under no illusion that returns are guaranteed. She says: ‘A good fund should deliver steady returns. That is the key’.
Darius McDermott, who runs ratings website FundCalibre, says only seven targeted absolute return funds pass muster. They are: BlackRock European Absolute Alpha, BNY Mellon Absolute Return Equity, Church House Tenax Absolute Return Strategies, Henderson UK Absolute Return, Old Mutual Global Equity Absolute Return, Premier Defensive Growth and Smith & Williamson Enterprise.