The giants of Multi-Asset Absolute Return fund sector

This was originally published in Investment Week

In recent years, the fund sub-sector seeing the greatest inflows has been the Multi-Asset Absolute Return sector, home to several of the largest individual UK funds. The attraction to investors of these funds has been the promise of returns well above cash for limited amounts of volatility, and sophisticated investment processes aiming to exploit opportunities across all asset classes. The giants of the sector are shown in the table.

AuM £m Fund 1 yr ret % 3 yr ret % 5 yr

ret %

Launch date
26,560 SLI GARS -2.4 7.7 23.2 29/01/08
9,824 Newton Real Return 11.2 15.8 28.4 01/04/04
7,197 IP Glob Target Return 3.0 16.2 na 09/09/13
2,562 AIMS Target Return -0.4 na na 01/07/14
1,571 AIMS Target Income 2.6 na na 30/11/14

Source: IW 10/10/16, fund factsheets

Funds such as Fulcrum Diversified Absolute Return and Goldman Sachs Global Absolute Return have similar objectives and approaches but have not yet seen investor flows to the same extent.

All of Newton, SLI and IP have, to date, broadly achieved their return and risk objectives over the recent 3 or 5 year horizons, but it is noticeable that none of these funds have generated much performance from the large decline in sterling post-Brexit (Newton have held a relatively high sterling weight in recent months.  This is in stark contrast to most of the more traditional fund sectors where beta returns predominate, which have been significant beneficiaries of sterling’s fall.

Hindsight shows that, once again, where funds flow from investors is heavily focussed in one sector, that sector tends to lag in performance behind less-favoured sectors.

Newton Real Return is the Grandfather of the sector, launched over 12 years ago, aiming at long term returns of cash +4% before fees over rolling 5 year periods and positive returns over rolling 3 year periods. They aim to achieve this by investing predominately in equity and bond markets, and control net market exposures through active hedging of equity and currency market risk. It can be best seen as a balanced fund that actively hedges its total equity exposure. Iain Stewart has been in charge since the fund’s launch and has delivered a positive return in every calendar year to date. This was particularly noteworthy in 2008 when the portfolio was well prepared for collapse in equity markets, but performance was disappointing in the 2012 to 2015 period when he held a relatively cautious view on equity markets. However, the last 12 months have returned 11.2% as the exposures to long duration government bonds and to gold have paid off handsomely, in addition to strong equity sector selection performance. This recent good performance has more than recovered the prior lagging performance, whilst maintaining low volatility.

SLI Global Absolute Return Strategies is the Big Daddy of the sector, the largest fund in the entire UK funds market, launched in early 2008, aiming at returns of cash +5% before fees over rolling 3 year periods. It uses a combination of traditional assets such as equities and bonds and modern strategies that make use of advanced derivative techniques, which give access to other asset classes such as interest rates, volatility and inflation. These techniques mean that the gross positioning of the fund has often exceeded 400%, though the rigorous risk control measures have meant limited portfolio volatility over the life of the fund. It is most easily understood as a hedge fund, though without the performance fees. The portfolio consists of around 40 different “ideas” which are each expected to deliver positive returns on a 3-year view, which are then blended together. For an advisor or end-investor it does mean that it is difficult to understand how the fund is actually invested in contrast to the far more straightforward portfolio positioning used and reported by Newton.

An otherwise very steady performance record has been damaged by the fund’s struggles over the last year, with a loss of 2.4% over that period. The team have struggled with their key long term market view of a stronger US economy, and this view was reflected in many of their positions, in particular their short duration position in US bonds, the significant long position in the dollar and a US Banks v Consumer Staples equity position. Some fund research houses also have cited the sheer volume of assets now managed by the GARS team (over £150bn) as a possible factor behind its declining performance in recent times.

Invesco Perpetual Global Targeted Returns is more like the oldest son in the sector. It was launched when three of the GARS investment team left SLI to move to Invesco Perpetual in 2013 and it adopts a similar investment process, though tends to operate with fewer individual ideas at any one time. Like GARS its gross positioning is substantial and makes considerable use of complex derivative techniques and aims to generate a positive return of cash +5% before fees over rolling 3 year periods with less than the volatility of global equities.  One difference in approach is that many of the talented equity managers at Invesco, such as Mark Burnett, manage equity “sleeves” for the GTR team thereby adding an extra element of return from individual stock selection that has absent at SLI.

AIMS Target Return and Target Income are the younger son and daughter of this family. Target Return was launched in July 2014 and Target Income in November 2014. Euan Munroe who built the original GARS fund is now CEO of Aviva Investors and the whole of their business is now centred around providing ideas for the multi-strategy fund range. The Target Return fund, like the others in the sector seeks positive gross annual returns of cash + 5% over rolling 3 year periods. In its objectives and approach the fund is similar to the SLI and IP offerings.

The Target Income fund, unique within the sector, seeks a pre-tax income return of cash +4% pa paid monthly, whilst maintaining the capital value after fees, regardless of market performance. In order to generate the high level of income targeted, a large part of the portfolio has to be invested in high-yielding equities and in bond markets, typically taking on some credit risk. Market hedging, multi-asset ideas and techniques are then added to the portfolio in order to seek to produce an absolute return profile.

Neither fund has yet built a 3-year track record – both performed well from launch until April 2015, but have struggled to make further gains since then.

The returns of GARS

This was originally published as an article in Investment Week

SLI Global Absolute Return Strategies (GARS) started life as a retail fund in May 2008 (and has become the largest retail fund in the UK market) though as a strategy available to external investors, it was launched by Standard Life in the summer of 2006. Its investment objectives are to achieve a total return of cash plus 5% (gross of fees), over rolling three-year periods, roughly consistent with the long-term returns from equities, but to deliver this with only one-third to one-half of the volatility of equities.

The team has sought to generate returns from a variety of sources, using both traditional investments in equities, bonds and real estate, as well as currencies, interest rates and volatility. Additionally it uses advanced investment strategies such as relative value and directional returns. By enhancing the number of return sources, they aim to enhance diversification and provide a smoother path of returns.

In their marketing, the team at Standard Life has distinguished between four types of return: Market Beta, Security Selection, Relative Value and Directional, labelling the first two as traditional and the latter two as advanced.

Over the period from July 2006 to the end of 2015,  GARS has generated a total gross investment return (before fund fees and costs) of 71.47% from these strategies. Since 2008 the fund has been invested in between 30 and 40 individual strategies at any one time.

Using data provided by SLI, attributing performance by individual strategy on a quarterly basis since 2006, the individual strategies were classified into each of the four types of return. A fifth type, Other, was created for this analysis,which is essentially the return generated on cash holdings.

  • Within the Market Beta classification only those strategies which appeared to involve being long a sector or market in the equity, bond or property markets were included.
  • Within Security Selection, only the strategy return for security selection provided by SLI was included. Security Selection involves going overweight some securities (relative to an index) and underweight other securities. This is an alpha return.
  • Within Relative Value only those strategies which were described as one asset type versus another; for example European vs US volatility, UK vs German short-rates, German vs French equity were included. In addition, an S&P call calendar spread and various cross-asset strategies were classified as Relative Value. Relative Value trades involve going long one asset and short an equivalent value of a second asset. Returns from Relative Value are also alpha returns with no associated market risk premium.
  • Within Directional strategies in interest rate and currency markets, strategies investing in volatility and dividends and yield curve strategies were included.
  • Within Other cash, liquid instruments and a small unexplained residual, which amounts to -0.2% over the entire period were included.

Analysis of returns by strategy type

  1. Beta returns from investment in equity markets have been reasonable overall at 8.7%. Equity market exposure cost investors heavily in 2008, but fared better in 2009 when a proportion of the 2008 losses were made back. Beta from fixed income market exposure has generated positive returns in every calendar year, with 2009 and 2012 being the strongest years thus far, totalling 20.1%. The team correctly positioned the fund in anticipation of strong performance in the corporate bond market in both of these years. Returns from occasional forays into real estate investment detracted in 2008.
  2. In the original marketing of the GARS strategy, the team’s target was for security selection to contribute about 1% per annum to the fund’s returns. However, the managers have struggled to deliver even 1% of return (0.9%) over the near-10 years since launch. It is this strategy that has been the most affected by the enormous inflows into the fund in recent years.
  3. The returns from Relative Value of 7.6% since launch are less than 1% per annum, although they have been positive in eight of the ten calendar years since launch. The negative contributions from equity and cross-asset Relative Value strategies since launch are disappointing, clearly indicating that the team has struggled to find good alpha-generating ideas in these areas. They have though had some success in Relative Value strategies in rates and bond markets and in volatility across markets.
  4. The greatest generator of returns has been from Directional trades (32.0%), and within those, from trading strategies in interest rates and yield curves (21.4%). Alongside the team’s good calls in fixed interest markets generally in the beta portion of the portfolio, these markets were very fruitful for investors from 2006 until 2011. However, since then only small returns have been generated from these strategies.
  5. Over the last three years, total returns of 7.5% from Directional strategies have been generated almost exclusively from the currency markets, nearly all of which has come from trades where the US dollar was the long position.

Analysis of returns by underlying asset class

  1. FIXED INCOME Performance attribution by strategy shows that the bulk of returns (47.2% from a total gross return of 71.5%) in GARS have come from strategies, both traditional and advanced, in the money and fixed income markets. Combining Fixed Income Beta, Rates & Bonds RV and Rates and Yield Curve Directional as Fixed Income strategies, returns here amount to almost two-thirds of the total return to investors over the period. Well-timed moves into strategies that benefitted from falling interest rates and bond yields in the second half of 2008 were particularly profitable and did much to offset the losses from equity strategies at that time. However, since Q3 2014 returns from these fixed income strategies have been negative. It may be coincidental but the timing of this change in the pattern of returns occurred when Ian Pizer, a key contributor of fixed income duration ideas to GARS, left SLI to join Aviva.
  2. EQUITIES Combining Equity Beta, Equity RV, Dividends and Security Selection as Equity strategies, returns here amount to 9.2%, which since inception is less than 1% per annum. This must be viewed as disappointing given the opportunities that have prevailed for returns from both long-only and long-short strategies over this period of time.
  3. CURRENCIES From 2013 to 2015, returns from currency strategies have formed an increasingly important part of the fund’s total returns. Prior to 2013, currency strategies had generated little in the way of returns. Almost all of the returns since 2013 have come being long the US dollar.

Conclusions

  • Over the history of the strategy to date, GARS has broadly met its long term total return target.
  • These returns have come from both advanced investment strategies (Relative Value and Directional strategies typically used in many hedge funds) and more traditional sources of market return (the Beta and Security Selection strategies). The advanced strategies have delivered 39.6% of gross returns, while the traditional strategies have delivered only 27.6% of gross returns. This dependence on advanced strategies (alongside the large gross positioning that is required to implement some of these strategies) may be surprising to investors who have not looked deeply into the GARS investment process.
  • GARS has generated its returns principally through strategies based on investment in fixed income strategies. It generated good returns from being positioned in corporate bonds in the strong markets of 2009-10 and 2012-13 and positions aimed at benefitting from lower interest rates across the yield curve. However in recent years this source of returns have dried up.
  • Equity strategies have generated only beta-type returns, with little value added from security selection or market timing.
  • In recent years, a correct call on US dollar strength has supported returns as bond and interest rate strategies have struggled to maintain performance.

Did fund size matter to performance in 2015?

This was originally published in Investment Week

2015 saw the two largest funds in the UK market enjoy very different fortunes. Continued strong inflows into SLI Global Absolute Return Strategies (GARS) saw net inflows into the UK version fund to November of £2.6bn and its assets rise to £26.8bn, though total assets in the strategy now total over £44bn, whilst M&G Optimal Income saw net outflows to November of £6.2bn and its assets decline to £16.3bn. GARS’ performance of 2.2% in 2015 was below its 3-year average rolling target return of Cash +5% gross of fees, but nevertheless was a reasonable outcome in a tricky year for financial markets – the inflows came on the back of delivering good performance over previous years whilst staying within its volatility target of 4-8%. For Optimal Income however, disappointing performance in 2014 relative to its Morningstar category and a decline of 1.2% in 2015, along with increasing investor concerns about future returns from bond funds as the Federal Reserve moved closer towards raising interest rates, have come together. For both funds, size has meant that it is increasingly difficult to generate meaningful outperformance from individual security selection, which was a feature in the early days of both funds. However both funds seek to deliver returns from a wide variety of sources of alpha, which are generally asset-allocation and top-down in nature. Even though both funds appear to be very large, given their aims to trade in the money, bond and equity markets all over the world and their ability to use derivatives to efficiently manage exposures, we don’t think liquidity is as pressing an issue as it might seem. M&G’s recent disappointing performance was mostly due to its underweight stance on duration in its bond holdings. This stance could be reversed quickly through the use of derivatives even for a large fund like Optimal Income.

If there were an impact of size on fund performance, the expectation would be that relative performance would deteriorate over time as funds become more unwieldy to run. Where issue selection or rapid trading of less liquid securities is key to a fund’s success, this is a common scenario. However, there is also the notion of “reflexivity”, whereby a large fund that starts to see outflows is forced to sell down its largest positions which damages the prices and performance of the rest of the portfolio. This can also work positively as funds seeing inflows buy more of their favourite positions, so boosting prices and performance.

In most categories, the fund universe is highly fragmented and UK funds are small relative to their market liquidity. In addition, funds which are long term investors in the companies they invest in and thus have low portfolio turnover, are able to cope with large size much more easily than funds with high rates of portfolio turnover as they demand less liquidity. If a fund’s strategy is contrarian in nature, it may also be a liquidity provider—selling when others are buying and vice versa—allowing it to run at a greater scale than would otherwise be the case.

The largest active UK equity funds are the Invesco Perpetual High Income and Invesco Perpetual Income funds, now managed by Mark Barnett, following the departure of Neil Woodford in 2014, at £12.6bn and £6.5bn respectively and Neil Woodford’s new fund CF Woodford Equity Income at £8.0bn. All three of these funds performed well in 2015, the Woodford fund performing exceptionally well (with performance of 16.2%) whilst dealing with inflows of £2.9bn over the year.  The largest contributors to the excellent performance of the Woodford fund were the exposures to healthcare and tobacco, two themes in which he has been invested for well over a decade – at year end he held a 7% position in Imperial Tobacco which rose by 33% in 2015 and was the largest single contributor to the performance of the FTSE All Share index. A further 3.5% position was held in Reynolds American which rose in value by 56% in 2015. The healthcare exposure performed well on the back of much smaller or unlisted holdings. Woodford has run enormous amounts of money for some years now, but his excellent stock-picking and low-turnover style has meant that he has been able to deliver strong performance despite the size of his portfolios.

Mark Barnett‘s approach has been slightly different to that of Woodford – he is less inclined to hold unlisted companies and tends to hold smaller positions in his most favoured stocks. Whilst his funds saw heavy outflows in 2014 as Woodford left Invesco Perpetual, these tempered over 2015 as investors have seen him continue to deliver good performance on these funds. His performance in 2015 of 9.3% for the High Income fund and 8.4% for the Income fund, were comfortably ahead of the benchmark index and sector peers, and this followed very good performance in 2014. The size of his funds and his similar low-turnover style has not led to any difficulties in generating excellent performance.

The sector which would be naturally least liquid and where size could quickly prove to be a handicap for managers is UK Smaller Companies. However, in 2015 the two largest UK smaller companies funds, SLI UK Smaller Companies and Marlborough Special Situations, both of which ended the year over £1bn in size, delivered 28.2% and 19.2% respectively, strongly ahead of both the benchmark and the category average. Many funds outperformed their smaller companies’ benchmarks last year, where the resource-related stocks performed very poorly but many domestic industrial stocks performed very well.

Star manager transition – a case study

This was originally published in Investment Adviser

Very successful (or ‘star’) managers are a double-edged sword for asset management firms. The assets they attract are fabulous for the firm when all is well and times are good, but even the most successful managers don’t want to do the job forever, and when they decide to move on, the assets, revenues and profits of the asset manager can, and typically do, fly out of the door even faster than they came in.

In a world of increasingly centralised investment propositions, a relatively small number of fund selectors can simultaneously decide that a fund is no longer preferred and a manager change can be that trigger. This can quickly generate huge outflows as those following their models take action.

In recent years, the resignations of high-profile names such as Richard Buxton and Neil Woodford have forced asset managers to implement their succession plans at very short notice. Within a year of the announcement of their resignations, Woodford’s IP Income fund lost about £4bn of assets and Buxton’s Schroder UK Alpha fund lost a little under £2bn of assets.

In these cases new managers spend their first few weeks in charge of their funds involved in presentations to key fund selectors and analysts in a desperate bid to persuade them that there will be no ill-effects from the loss of the previous ‘star’ manager.

However, where a successful manager is not seeking to set up a similar fund in direct competition with his or her previous employer, a well-managed firm has the opportunity to handle the transition in a much more orderly manner. This is not easy, but the recent transition from Ian McVeigh to Steve Davies at Jupiter UK Growth provides several lessons in how it can be achieved.

A long-term perspective on the transition is essential. First the succession manager must be identified – at Jupiter, Davies joined McVeigh as his deputy manager on the fund in 2007, but crucially this initial move was based on the two sharing a very similar investment philosophy and approach. Initially this meant they formed a strong and successful duo, and as time went on, Davies’ previous experience as a retail sector analyst was a key and visible contributor to the success of the fund.

In 2012 Davies was given responsibility for the Jupiter Undervalued Assets fund which he managed to a very similar mandate to the UK Growth fund. This allowed him to demonstrate his own track record as a lead manager. He also increasingly took on marketing responsibilities for the UK Growth fund so that he was a familiar face to the fund selection community.

In 2013 Davies was promoted to co-manager with McVeigh on the UK Growth fund. Then, earlier this year, with Davies having successfully established a three-year track record in his own right and continuing the very successful track record on UK Growth, Jupiter announced McVeigh’s move to another role within Jupiter looking at corporate governance, and Davies’ transition to sole manager of the fund. His Undervalued Assets fund would also be merged into UK Growth.

The fund selection community was thus carefully prepared for Davies to succeed McVeigh. By the time the transition occurred, fund selectors knew Davies, knew that his investment process would be similar to that of McVeigh, and had evidence that Davies was a strong manger in his own right.

The success of this key manager transition from Jupiter’s perspective can be measured by the fact that given McVeigh’s excellent long-term track record on the fund, there have been small net inflows since the announcement of the manager change.

 

From CIO to CEO

This was originally published in Investment Week

The elevation of Richard Buxton to CEO at Old Mutual Global Investors brings to the fore the issue of how investors should feel about great investors taking on the role and responsibilities of CEO of their company.

As with all such discussions there are positive and negative factors to consider, and although the precise extent of responsibilities will vary, in general there are more factors that cause concern than there are those that cheer.

On the positive side, having a successful investment manager appointed to be CEO of the fund company is tremendous for morale within the investment management team. The team know that at the head of their firm is someone who understands their needs and frustrations, understands the vagaries of investment performance, values the (often rather invisible) work they do and is not likely to take the firm in directions that take the focus away from delivering investment performance. This supports both the retention of incumbent fund managers and the recruitment of new ones. Happy fund managers can devote their energies solely to generating good performance.

Set against this are the concerns.

The first of these is sufficient time in the day. Where an investor seeks to combine the roles of CEO and CIO then there is a clear risk of overstretch and of not doing either job well. After all, both are normally considered to be demanding, full-time roles in their own right. The major risk is that, since, ultimately, most things end up in the CEO’s inbox, the time available for (longer term) investment responsibilities gets eroded by the (shorter term) demands of the business, and this ends up being reflected in poorer investment performance.

In addition, being a good CIO is very different from being a good CEO -there are significant differences in the two skillsets.

  1. A CEO needs to be a strategic thinker about the firm across many departments, whilst an investor is focussed on a relatively narrow set of investment opportunities and assessing their relative attractiveness within the context of ever-changing market prices.
  2. A CEO needs to be able to effect and deliver change, whilst an investor merely needs to take advantage of it by identifying when it will be implemented successfully.
  3. A CEO needs to inspire his management team and his workforce across a range of disciplines. A CIO merely needs to inspire other investors, who are likely to be people like him.

This is not to say that a CIO cannot be a good CEO, merely that the skills that made him/her a good CIO are probably not those required to make him/her a good CEO.

In recent years the most high-profile move from investor to CEO has been Edward Bonham-Carter at Jupiter. He proved to be an excellent CEO but he was not able to combine that with continuing to deliver good investment performance and ultimately pulled back from managing money.

The early sense about Richard Buxton’s elevation is that his role will remain extremely investment-focussed but that Old Mutual Global Investors were keen not to have a position with the title of CIO. His role is, however, intended to be that of investment leader. The bulk of what would normally be considered the CEO’s responsibilities at Old Mutual will be covered by Warren Tonkinson, who has been given the title of Managing Director. If this is borne out in the months ahead then it may well be that this CEO can continue to deliver for his investors.

4 lessons for Investment Trusts post Patient Capital

This article was first published in Investment Week

The news that Neil Woodford’s new vehicle, Woodford Patient Capital Trust plc, has raised more money at launch (£800m) than any other UK closed-end investment company in history provides an opportunity for the industry to re-establish itself in the eyes of many investors as a suitable repository for their savings. In order to achieve this, however some lessons must be learned.

Lesson One: Investors will buy closed-end funds when the structure adds value to their portfolio and is the appropriate one for the underlying investments.

The illiquidity of the fund through the unquoted nature of the majority of the fund’s expected portfolio meant that an open-ended vehicle could not be countenanced. The private equity investment trust, which Patient Capital is closest to in nature, has a well-established history and pedigree in the UK market and though the share prices of these vehicles have proved to be volatile in the short term, the fact that they provide long term fixed capital to managers has enabled many to deliver excellent long term performance. Only those investors who lose patience and sell their shares at discounted prices in difficult market conditions stand to miss out on the longer term performance.

In recent times investment companies investing in other specialist less liquid asset classes such as very small listed companies, property and loans, have also taken advantage of the closed-end structure.

 

Lesson Two: Investors will buy closed-end funds when there is a strong and trusted brand.

Woodford is an eponymous brand that has very strong recognition amongst private investors, and most importantly, a high degree of trust. There are few in the UK fund management industry who have made so much money over such a long time period for so many investors.

Recent media stories of pay in the asset management industry now outstripping pay in investment banking, combined with the rise of the passive investment industry attacking the performance of active managers, have been damaging to the image of the industry, as have the Financial Times’ surveys showing that sexism is rife within asset management companies.

 

Lesson Three: Investors will buy closed-end funds when the fees are attractively constructed.

Woodford has hurled a huge stone into a large pond that was already experiencing some ripples. There is no ongoing asset management fee at all (though there is an ongoing expenses charge capped at 35 bp). The manager will be remunerated exclusively through a performance fee of 15% of any performance above a hurdle rate of 10% per annum – 80% of this fee will be paid in shares priced at the prevailing NAV. These are terms that treat the underlying investor well compared with many other private equity vehicles.

It is clear that Woodford’s interests are well aligned with his investors. In today’s world of disappearing bond yields, zero fees before a 10% return is achieved, is very attractive to a retail investor. Morningstar’s position on performance fees is that, where they are appropriate at all, they should be tied to lower than normal fixed fees so that the manager has some hunger to achieve the performance necessary to earn a performance fee. Performance fees are most appropriate where returns are skewed towards alpha rather than market beta.

Investment company fees were already under pressure from the increasing prevalence of platform and super-institutional or super-clean share classes amongst open-ended funds. Both existing investment companies and future new launches need to look hard at their fee structures to ensure they are appropriate for this new environment. Woodford’s attractive fee structure has undoubtedly contributed to its successful launch.

 

Lesson Four: Investors will buy closed-end funds when there is a credible Board with the appropriate skillsets.

Patient Capital has four Directors, all non-executive and all with substantial experience of managing or investing in early stage innovative businesses in healthcare and technology. These are highly relevant skillsets for overseeing the type of portfolio that Woodford is seeking to build with the £800m raised at launch. From the biographies in the Prospectus, none of the Directors have, however, had any previous experience on the Board of a listed investment company nor do any of them appear to be a qualified lawyer, both of which are unusual.

An ideal Board has the asset class or sector experience to quiz the manager stringently, an accountant for the Audit committee, Board experience of other investment companies, and legal experience should controversies arise.