One aspect of our multi-asset fund asset allocation that has historically taken up a lot of airtime during investment committee meetings is that of the ‘alternative’ sector, which can often be rather subjective in its interpretation and the subsequent merits about inclusion in the portfolios questioned.
My own views are not necessarily representative of the wider MitonOptimal team, but allocating to ‘alternative’ funds comes with a large degree of outsourcing an element of control and asset allocation, as few funds in this space follow any prescribed benchmark.
After quite extensive analysis of the funds that make up the large part of this universe, it is apparent that few perform with the consistency that one desires. Additionally, the returns being offered on a ‘risk versus return’ appraisal rarely stand out as exceptional.
Therefore, it is little surprise that we have purposefully reduced our allocation to this asset class (if it can truly be described as an asset class) and shaped our own ‘libor plus’ mini strategies. Whether this is allocating more capital to bonds and equities on a 20/80 split, or simply buying short duration investment grade bonds, the results are both more predictable and delivered with a level of risk that is within budget – no excessive ‘gross exposures’ or derivative use to be observant of.
We acknowledge a sector average is simply the sum of the parts, and within the sector there will always be stand outperformers. There are currently 120 constituent funds in the IA Targeted Absolute Return sector, with the best performance over three years being an exceptional return of 89.35% (Polar Capital UK Absolute Equity) whilst the worst performance was negative 21.03% (GAM Star Discretionary FX).
This displays the huge disparity of returns, and in turn, the difficulty in selecting the best / most appropriate alternative fund for one’s portfolio. Analysing the performance of the sector over one, three, five and seven years also leaves us underwhelmed relative to other asset classes adopting similar or lower risk characteristics.
The sector has delivered 0.6%, 4.7%, 12.8% and 17.9% over the observed time periods (to 30 June 2018), whilst a basket of short duration bonds, represented by the iShares £ Corporate Bond 0-5yr ETF which has an effective duration of 2.7 years, has delivered 0.6%, 7.1%, 15.1% and 26.5%.
In isolation, this performance data carries limited vindication, but what adds more colour is the fact over three of the four time periods the level of volatility has also been lower using short duration bonds. The exception being the seven-year data, however, the outperformance justified the additional volatility. We must also recognise the number of funds within the sector for this entire sample period is somewhat different to the makeup today.
Finally, observing the five largest funds in the sector by AUM (a remarkable total of £61.2bn), four have made a loss in the last 12 months and two have made a loss in the last three years (to 30 June 2018), despite being managed by some of the best-resourced teams money can buy. This statistic I believe highlights the task facing most alternative fund managers is not far short of outright impossible at times.
We do remain open to re-evaluating our stance should the market dynamics change materially, particularly with Quantitative Easing now entering the twilight of its existence. This does of course leave some questions unanswered with regard to the future of bonds markets, and this policy shift may play into the hands of the ‘alternatives’. However, our belief is that there will be little impingement at the short end of the curve, whilst paired with our active stance in managing both the duration and the credit quality of our bonds as we see appropriate, we are unlikely to revisit alternatives in a meaningful way anytime soon.
Download: Weekly Comment – July 26 2018 – JS