The turbulence of public markets over the past two years have led some asset owners to increasingly favour absolute return strategies as a means of countering counter market volatility.
In October, Taiwan’s Public Service Pension Fund (PSPF) invited bids for a five-year domestic equity investment mandate of up to NT$20 billion ($654.6 million) that utilises such a strategy, with a a senior PSPF official saying it was a useful defensive measure in uncertain market conditions.
The asset managers that are awarded the mandate will be required to meet a target return of 200 basis points above the average dividend yields of stocks listed on the Taiwan Stock Exchange's main board over the past five years.
PSPF is not the only one. In mid-2018, several institutional investors looked into absolute return fixed income strategies as a means of adjusting to anticipated volatility amid what was then assumed to be a period of continued hikes in US interest rates.
The market outlook for 2020 is also uncertain, with interest rates unlikely to rise but the prospect of strong market performance also questionable, given high relative valuations and few signs of robust economic strenght. Will this raise the appeal of absolute return strategies versus relative return ones, and if so would investors seek to employ them mainly for fixed income or equity assets?
AsianInvestor has asked four investment professionals to share their views for this topic, which is part of our 2020 market outlook series.
Their contributions have been edited for clarity and brevity.
Anubhuti Gupta, head of portfolio management and director for Asia, Rosenberg Equities
Axa Investment Managers
We have been in an unprecedented decade of low volatility, low yields and rising markets. However, as we enter 2020, there are valid concerns about market correction and higher risk.
Absolute return benchmarks will increasingly find greater appeal with asset owners as relative returns can be great but the problem is that when the markets fall, their plans are going to fall. If the market is down 20%, even with a stellar 10% relative return or alpha in other words, you are down 10%. Alpha alone will not save you.
Absolute return strategies generally emphasise capital preservation, risk management and greater flexibility – all important factors investors seek to maneuver difficult market environments.
That said, relative returns strategies will continue to remain a key component for implementing asset allocation decisions. Relative return and beta strategies allow asset allocators to express their views on market efficiency and the resulting degree of activeness they want to pursue in different aspects of their asset allocation plan.
The adoption of absolute returns will play out in a similar fashion for both equity and fixed income space because asset owners will target absolute returns with a focus on risk-mitigation and downside protection, regardless the asset class.
Cheung Chilok, portfolio manager, delegated solutions
The global economy continued to slow down, with the manufacturing downturn deepening and services still holding up, albeit weaker than before. Capital expenditure is still sluggish amid the ongoing trade uncertainty on a number of fronts. Also, the global economy remains subject to a number of unpredictable geopolitical shocks that could change the direction of the markets.
With that, we continue to stress the importance of reviewing asset allocations in portfolios to ensure we can stay confident in achieving target returns with the chosen risk profiles.
Depending on investment objectives, both absolute and relative return strategies have roles to play due to differences in risk characteristics. We typically combine both in portfolios to refine and reflect target sensitivities to the broad fixed income and equity markets.
With softening of global growth and subdued inflation, central banks are likely to keep rates low. Absolute return fixed income strategies, and, in particular, the defensive ones with flexible duration profiles, are expected to be in most demand again. They have proven to be the missing element in defensive portfolios.
Absolute return-focused equity strategies do generally improve the overall risk-adjusted return profile of portfolios, but they typically belong to a higher risk category of investment strategies.
Fraser Lundie, head of credit
Hermes Investment Management
Credit markets have developed rapidly over the past two decades as post-financial crisis regulation and the growth of emerging markets have encouraged investors to look at different regions, sectors and instruments. Volatility is also on the rise as late-cycle dynamics, a lack of clarity about the pace of monetary easing and geopolitical turmoil create an atmosphere of uncertainty.
In this world, investors can no longer rely on a standard, long-only approach to generate returns. Absolute return credit strategies aim to deliver positive returns throughout the cycle, regardless of whether markets rise or fall. These funds look beyond traditional benchmarks and act as a more market-neutral solution – particularly in times of turbulence.
Absolute return credit strategies are highly responsive to market conditions, while continuously harvesting the income available from the asset class invested in. When markets are weak, investors tend to turn their attention to defensive assets, like government bonds, or use downside-protection strategies to hedge risk. And if markets are buoyant, they can position themselves to capture the upside.
In today’s late-cycle environment, there is more of a need than ever to stay flexible and invest across all credit classes. Absolute return credit strategies attempt to navigate this uncertainty by employing a go-anywhere, all-weather approach to fixed income.
Alex Johnson, head of absolute return multi-sector fixed income
BNP Paribas Asset Management
Are we under-pricing the “risk” that things get better? A deal on trade or at least recognition of something like a high-water mark looks possible. The chances of more left-leaning candidates like Elizabeth Warren securing the Democratic Party nomination look to be receding, and we can expect President Trump’s Republicans to promise further tax cuts or infrastructure spending.
In addition, a no-deal Brexit seems very improbable. It is tempting to believe we have seen a bottom in European data, and that political risk in Italy will not in fact materialise.
In other words, it is quite possible that the expansion will roll on into 2020, and bonds priced for recession risk will need to reprice.
So why absolute return strategies? Because rising yields enhance cash returns. No benchmark means not being tied into duration risk. Flexibility means going where the opportunities are, and not the same correlated assets as everyone else. In short, absolute return strategies offer the chance of uncorrelated positive returns maintaining a store of value: in short, delivering what fixed income is actually for.