For reasons outlined in this Featured Article, GillenMarkets, as an impartial investment advisor, is no longer recommending hedge or absolute return funds as part of balanced or multi-asset portfolios. Our advice is that investors should stick to balanced funds that own the traditional assets of equities, bonds (nominal and inflation-linked), cash and alternative assets. Our analysis also raises some broader questions; whether Irish institutions should be marketing absolute return funds to the retail public on the basis of ‘bank deposit returns plus 4-5%’ when they seem incapable of delivering such returns, and whether the Government’s Irish Strategic Investment Fund (ISIF) ought to have 28% of its assets in such funds?
The Global Financial Crisis (GFC) not only created nerve-wracking volatility in the global financial markets during the 2007-09 period, but for many private investors who were inadequately diversified it also created permanent losses on a scale not seen since the early 1930s.
Traditionally, balanced or multi-asset funds, which own equities, bonds and alternative assets, were aimed at providing exposure to the higher returns on offer from growth assets (equities) while also covering investors for the major economic risks (of recession, deflation and inflation) with the caveat that returns would be lower over time than those likely to be delivered by equities. However, balanced or multi-asset funds in Ireland have tended to have circa 65% to 70% exposure to equities so that, in reality, they tended not to be all that balanced, and also suffered heavily in the GFC.
As a consequence, demand for investment products capable of lowering volatility, providing diversification and offering the Holy Grail of consistent positive returns above inflation increased significantly post the GFC.
In Ireland, this manifested itself in the wide-scale promotion of Absolute Return Funds. However, these fund types are not delivering for investors, and we believe the issues involved are largely structural in nature rather than cyclical.
Over the 15-year period from 2003 to 2017 inclusive, returns from the HFRX Global Hedge and Absolute Return Funds Indexes have been 1.8% and 1.2% compound per annum, respectively. As the chart above highlights, returns from the hedge funds universe were only marginally ahead of inflation over this period; for the absolute return funds universe, returns were actually below inflation.
High costs, too much capital chasing finite trading returns and low to zero returns from risk-free assets are the likely reasons for these paltry returns.
While many of the absolute return funds promoted in Ireland have not been around for the 15-year period under review, none have delivered to expectations or to the marketing hype in the period that they have been available.
The higher profile absolute return funds promoted in Ireland include the Aviva Multi-Strategies Target Return Fund, the Irish Life Multi-Manager Target Return Fund, the Invesco Global Targeted Returns Fund, the New Ireland BNY Mellon Real Return Fund and the Standard Life GARS Fund. The list in the table is not an exhaustive one.
Be Careful How You Promote the Product?
With the above facts now available, institutions in Ireland promoting absolute return funds should move away from suggesting that they can deliver ‘bank deposit plus 4% to 5% annual returns’, even over 3-year rolling periods. Only equities have delivered a premium return of circa 5% over risk-free assets over the long-term.
When you own equities (companies), you own productive assets capable of earning high returns on the capital employed in the businesses, and well ahead of the returns traditionally available from risk-free assets over most cycles.
Should Irish institutions continue to promote absolute returns funds on the same basis going forward they will be in danger of mis-selling the product, in our view.
Over the same 15-year period, returns from the Hedge & Absolute Return Funds universe have had higher correlation to equities than ought to have been the case further undermining the rationale for their inclusion in balanced or multi-asset portfolios. As the return statistics in Table 1 highlight, this trend of high correlation to equities has continued in 2018.
It’s therefore difficult to avoid the additional conclusion that the Hedge and Absolute Return Funds universe is not actually diversifying risks at all in balanced or multi-asset portfolios. In fact, they are increasing risk but without any commensurate improvement in returns.
In our view, then, the facts do not support the case for allocating savings to the cost-heavy, and more trading-oriented Hedge & Absolute Return Funds industry.
Our full research note can be accessed by clicking the PDF below.