October 22, 2020

The Top Gun Sector

by Dewi John.

Negative flows in the IA Targeted Absolute Return sector reflect the inability of its funds to deliver on investors’ expectations. Which begs the question, were those expectations realistic, and shouldn’t those nurturing them have known?

Fund flows began to slacken in 2016, and the sector has seen outflows every quarter but one (Q2 2018) since Q3 2017. This is exemplified by the experience of its former star player, the ASI Global Absolute Return Strategies (GARS) fund.

Between Q2 2016 and Q3 2020, GARS saw an eye-watering £22.8bn of net outflows. As an economist I once worked with never used to tire of saying, that’s a good night out. It’s more than the rest of the sector saw leave over the same period (£21.4bn). This indicates that much money circulated around the sector before heading out the door.

For example, the Invesco Global Targeted Returns fund carried on in positive territory until Q4 2018, since when it has had unbroken quarterly outflows totalling £5.3bn.

Let the Good Times Roll

Being old enough to remember Long-Term Capital Management, I’m always a little suspicious of financial engineering that promises that the (albeit moderately) good times will trundle on—and on. They seldom do.

The commitment of the sector to deliver “positive returns in any market conditions” is ambitious. So ambitious that whoever drafted the definition added “returns are not guaranteed”, and that funds “may aim to achieve a return that is more demanding than a ‘greater than zero after fees objective’” in a period no longer than three years.

So, you may make more than nothing over the three-year period. But no guarantee.

Many Paths, Same Moon

We need 17 Lipper classifications to cover the sector. Given that it has only 84 funds, that indicates the many styles represented: from long-short equity over a variety of regions to global bonds.

It’s fine to have outcome-orientated sectors, allowing fund managers to figure out how they get there: as the Japanese Zen monk and poet Ikkyu wrote, “Many paths lead from the foot of the mountain, but at the peak we all gaze at the single bright moon”. Though this was no doubt the inspiration for whoever drafted the Target Return sector definition, I wonder whether the heavily caveated outcome it’s couched in has much merit.

That these paths are so labyrinthine contributes to the sector’s problem. Complexity isn’t necessarily a bad thing. I don’t understand the principle of the jet engine with any clarity, but I still get on the airplane. Or did, back in the good old days. That said, asset management companies should have a good idea of how they are going to deliver on a fund’s aims without all those provisos. They at least should understand what all the bells and whistles entail.

Which brings me to the title of this article.

I confess, I have never seen Top Gun, nor do I ever intend to. I bear Tom Cruise no ill will, but it’s just not my thing. However, the one quote I know from his magnum opus is “your ego is writing checks your body can’t cash”. This seems apposite for the sector. The prospect of all those checks looking for a steady return, whatever the market was doing, was too good to turn down. But could they deliver?

Five—It’s the Magic Number

Individual funds beefed up the vaguer performance targets of the sector. GARS, for example, aims to “exceed the return of six-month GBP LIBOR plus 5% per annum, evaluated over rolling three-year periods (before charges)”.

Invesco Global Targeted Returns, currently the largest in the sector, “targets a gross return of 5% per annum above UK three-month LIBOR and aims to achieve this with less than half the volatility of global equities…over the same rolling three-year period.”

Aviva Investors Multi Strategy Target Return is “targeting an average annual return of 5% above that of the Bank of England base rate, before the deduction of charges, over a rolling three-year period,” again, with less than half the volatility of global equities.

Five percent above six- or three-month LIBOR, less charges, is where these funds tend to be pitched. There is a variety of total expense ratios across the sector, ranging from more than 2% to a few basis points (bps), but the average is 115 bps. Three-month LIBOR is 0; six-month is 0.25%. Let’s not quibble, and even out to an annualised 4% to be hitting performance targets.

 

Table 1: Annualised Performance of the 10 Largest Target Return Funds

Source: Refinitiv Lipper

Failing, Bit by Bit

The three-, five- and 10-year annualised average returns for Target Return are 0.77%, 1 .5%, and 2.82%, respectively. It’s clear that the sector overall has been progressively failing its investors (though I haven’t read all the fund objectives, I doubt this is what they aimed for).

Only one fund in the table above, Threadneedle Dynamic Real Return, scores a Lipper Leaders 5—the highest—over five years for both consistent return and capital preservation. Plus, it’s also got a below-average TER for the sector, at 0.92%. That seems more in tune with the intent of the sector.

Of note, too, is the BNY Mellon Real Return fund: with a TER of 1.37%, it has hit its objective of 4% before charges, delivering an annualised 3%-plus after charges over each annualised period.

The fund that has the strongest one and three-year return, FP Argonaut Absolute Return, makes no commitment to a given percentage over a risk-free index, instead aiming to “provide positive absolute returns in share class currency over a three-year rolling period, utilising a variety of asset classes and regardless of market conditions”.

Its Lipper Global classification is Alternative Long/Short Equity Europe, and has returned 47.4% over three years. At £34m, it’s barely a fraction of the monthly outflows of the sector giants. Its three-year annualised return is 13.8%, but its five-year figure only 2.6%, brought down by a very poor 2016, demonstrating that this isn’t a vehicle for those looking for a steady percentage growth each year. This is reflected in the fund’s low Lipper consistent return and capital preservation scores over five years.

The sector has delivered, on average, on its modest goals. But the targets that drew so many investors in are being missed—and by an increasingly wide mark.

 

Refinitiv Lipper delivers data on more than 330,000 collective investments in 113 countries. Find out more.

The views expressed are the views of the author and not necessarily those of Refinitiv. This material is provided as market commentary and for educational purposes only and does not constitute investment research or advice. Refinitiv cannot be held responsible for any direct or incidental loss resulting from applying any of the information provided in this publication or from any other source mentioned. Please consult with a qualified professional for financial advice.

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