Absolute return should avoid ‘no risk’ tag, says Kames Capital’s Colin Finlayson
Colin Finlayson, manager of the Kames Capital Absolute Return Bond Fund (Dublin) and support manager for the OEIC Strategic Bond Fund, says investors looking for absolute return strategies must recognise that they must still take some risk in order to get some return.
The fund industry faces a challenge in the area of absolute return fixed income because of the way some investors have been marketed such products in the past.
Instead, what investors need to understand about absolute return products of any kind is that while they may be “low risk”, they can never be “no risk”, says Colin Finlayson, who works on Kames Capital’s Absolute Return Bond fund.
Where investors might once have been offered only positive returns, they could have lost out if they ended up on the wrong end of risk, such as during the 2008-9 period.
The positioning of absolute return products should always avoid offering “no risk”, as that implies no return either, Finlayson says.
There is also a need to explain the reasons for taking some risk in order to achieve a return.
What absolute return should be able to offer is some downside protection. Investors should not have to rely on market Beta in order to generate returns. Instead they should be more focused on Alpha and Alpha strategies. Finlayson obtains his Alpha by accessing the market in three key ways: carry, credit and rates. Some 40% of the portfolio is focused on short dated, high quality corporate bonds. ‘Credit’ is about other corporate bond positions, while rates are about looking at government bonds. The focus is on the opportunities that arise from the relative performances of different assets.
Finlayson says his own positioning, regarding the fund he manages, also seeks to emphasise absolute return as a cash alternative, rather than necessarily a fixed income alternative.
He says he is looking for returns that do not bear any resemblance to what would be experienced in the ordinary fixed income market. It is about controlling risk, not chasing return figures.
The approach is one that would suit investors with excess cash sitting in the bank and which is essentially earning nothing. Therefore it is about saying to investors that if they take a little bit more risk they can make their money work a bit more.
Company cash piles
Finlayson says that the fact he seeks to position absolute return as an alternative to cash rather than fixed income means that there is also an opening to argue his case before companies that may be sitting on cash.
Equity shareholders who are pushing companies towards returning more of the cash they hold – dividend payments from the S&P 500 have reached all time highs recently. But Finlayson says “why not?” in answer to the question whether companies should consider absolute return funds as a way to make their cash work better. “It should be attractive for any type of investor.”
However, he notes that for the ‘cash alternative’ argument to work, funds need to ensure that they can offer daily liquidity – a particularly important point for markets in Europe. The fundamental ideas of Ucits and other Directives are therefore important in the absolute return debate.
Finlayson says that when the industry looks back in a few years’ time, it is likely to see the current environment of regulatory changes as the moment when investors were being provided more protection and more transparency, which will give Ucits funds a head start compared with hedge funds outside the framework.
Cost of Alpha
Committing to Alpha implies costs at a time when the industry is under intense pressure to control them. Finlayson admits his approach to absolute return is labour intensive, and the the returns it generates over, say, an 18 month period is at a level that equity funds may be able to generate in a week.
However, this is part of a deliberate positioning, which also sees Finlayson take a specific view of fees. “I just don’t see that there is a place for performance fees on this type of fund.” Thus it has to be priced accordingly, and in a way that does not put investors off.
There will be others who may offer higher return, but apply higher prices too; for the investor it is a case of considering the choices available.
Libor is the key benchmark for the type of absolute return approach that Finlayson takes.
Despite the furore over rigging of Libor he says it remains the best way to measure what return investors may be able to obtain overnight, and it remains most representative of what return investors could get for their cash.