Issue: September/October 2007
Edutorials
Investec

Absolute return fund ideally positioned for volatile market conditions

Over the past three to four years, we’ve had a global bull market characterised by high levels of growth and liquidity. More recently, however, market risks have been building up. Now the focus is on market uncertainty. Some of the risks have been caused by:

  • An uptrend in US, UK, European and Japanese interest rates;
  • Pressure on US sub-prime mortgage lending and the housing market, and its impact on consumer spending;
  • Concern about the Japanese ‘carry trade’ and the weak yen;
  • Over-leveraged global hedge funds.

Investors, including pension funds, have done well in equities but might now wish to reduce the downside risk to their portfolios. The Metropolitan Absolute Return Fund (ARF), an institutional investment vehicle, is particularly well suited for this purpose. In the form of a unit trust, there’s also provision for individual investors through the Metropolitan Absolute Provider Fund.

These are included in the offerings from Metropolitan Asset Managers (MetAM) which manages close on R2 billion of institutional assets and just over R48 million in unit trusts.

The potential for the ARF stems from the flat but volatile conditions that have come to affect the South African market. Absolute return funds can perform exceptionally well in bull markets, as reflected in MetAM’s one-year performance when the fund returned about 19%. Because investing in an absolute return fund is a way to ‘insure’ against loss, it is ideal when a conservative approach requires it.

MetAm’s ARF is a Regulation 28- balanced fund that includes a proportionate mix of cash, bonds and equities. The aim of the ARF is to manage the downside risk by providing a measure of protection, thereby preserving capital while meeting the performance target of CPI (inflation) plus 5%. Unlike the traditional balanced fund, the ARF provides a source of additional returns when the equities index moves sideways or falls.

The duty of the ARF’s portfolio manager to minimise the number of negative monthly returns. This is achieved through the optimal mix of the different asset classes. The ARF is managed so that its asset allocation uses the same inputs as the MetAM house view, but the asset allocation is adjusted in light of the existing risk-free rate and relative to the more volatile returns from equities and bonds.

Within the equity portfolio, the desired tracking error is achieved through a proprietary process independently (based on quantitative models) of the house view. The equity portfolio is also protected in different ways depending on market levels and the cost of the protection.

At the beginning of the year, ARF managers are especially conscious of the need to buy protection against the downside volatility of the equity index. This is based on a one-year forward view of the equity index. Later in the year, changes are made to protection levels when the returns are above zero and especially when they are above the performance target.

ARF team members include Met- AM chief investment officer Liston Meintjes; portfolio implementation and dealing head Eugene Goosen; and quantitative analysts Phillip Mashele and Morotola Pholohane. The team spans quantitative, derivatives, actuarial, mathematical and statistical skills.

Investors looking for good returns with minimal risk should seriously consider this type of fund.