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How to spot the true diversifiers

It's been a tough first half, and not just for equities. Fewer than 5 per cent of the 5,100 funds in the entire Investment Association (IA) universe produced positive returns over the first six months of 2022.

Investment trusts have done slightly better: almost a quarter have produced a positive return. But this doesn’t show trusts are inherently more resilient than their open-ended peers. Instead it’s an indication of how alternative sectors and asset classes now account for an increasingly large proportion of investment trust assets.

Not all niche sectors have done well this year – and investors holding the small band of private equity or venture capital strategies that are still in positive territory would do well to scrutinise positions carefully, given the direction in which most unlisted equity valuations have been heading. But a select band of real estate investment trusts, renewable energy infrastructure, and hedge fund strategies have served trust holders well amid the market carnage.

What of those open-ended funds designed to provide something similar to hedge fund performance? For those, we turn to the IA’s Targeted Absolute Return sector. One in four in this group have produced positive returns in 2022 – not particularly inspiring, given their stated aims.

Perhaps investors should not expect any better. After all, the sector name was changed, back in 2013, from ‘absolute return’ to ‘targeted absolute return’. Just to make it clear that positive returns are the hope rather than the consistent reality.

Yet the Investment Association itself acknowledges the “wide expectation” that funds in the sector will aim to produce positive returns over 12-month periods. Extend the time horizon from six months to a year, and the number of funds in the black increases by just four, from 28 to 32.

Absolute return funds themselves typically commit to a positive return over rolling three-year periods, as opposed to shorter time horizons. Over three years, improved performance is apparent – but a third have still failed to produce a positive return over that period.

Aggregate figures can be damning, but they don't tell private investors much about what has been doing well. On which note, perhaps the question itself should be reframed. The job of a diversifier isn’t to perform well in all conditions; it’s to do so when times are tough for risk assets. This year has been one such time: the FTSE 100 may have dipped 4.5 per cent, but mid-cap, small-cap and regional indices are down much further. That’s why year-to-date performance, while short-term in nature, is instructive.

Add to that the first three months of 2020, and investors now have two significant drawdowns to examine. Eight absolute return funds produced positive returns in both these periods, although five are not typically available on retail platforms. Of the other three, Argonaut Absolute Return (GB00B7FT1K78) is particularly volatile, with Man GLG Alpha Select Alternative (IE00B60K3800) the most consistent and Tellworth UK Select (GB00BTC2N411) somewhere inbetween.

In the investment trust universe, meanwhile, just seven portfolios were in the black over these two timeframes. Strip away the private equity and VCT offerings, and a sole renewable energy offering (Gore Street Energy Storage (GSF)), and just one is left: BH Macro (BHMG), which we last highlighted in our Investment Trust in the Spotlight segment in early April (‘BH Macro: still a port in the storm, IC 8.4.22). The trust has retained its admirable record of delivering strong returns right when equity markets are struggling. Viewed from this vantage point, the recent fee hike instigated by managers Brevan Howard looks like a price worth paying.