Absolute hell or real opportunity for capital preservation funds

MARKETS are providing the toughest credibility test in more than four years for the category of unit trust specifically designed to withstand downside pressures the absolute or real return fund pledged to fight for inflation-beating returns, but more importantly in this environment, to persevere capital.

STANLIB, the country's largest unit trust company and one of the pioneers of the real return concept, says current market uncertainty will be a true test of product design and investment philosophy in a category that has put in benchmark-beating performances for more than four years.

STANLIB portfolio manager Henry Munzara points out: "Between June and mid-August the JSE shed about 10% of its value with a fair amount of volatility. A time such as this can be absolute hell or a real opportunity for a category that has been marketed on the twin proposition of inflation-beating returns and capital preservation.

"Markets have been so favourable that on occasion an absolute return fund might beat CPI with 15-20% to spare. That's great for unit trust-holders, but meant there was no torture-testing of the underlying objective that portfolio construction and astute asset allocation would provide the safeguards the investor hoped for.

The absolute return category has been a beneficiary of the market swing to asset allocation funds as intermediaries promoted the benefits of delegating portfolio construction to investment professionals. The point was well made as the average retail investor is not normally equipped to align the weightings of various asset classes with market movements.

Asset allocation expertise became a key part of the absolute return 'promise' as these products often contain equities, bonds, property, cash and perhaps an offshore component.

All of these elements is represented in the STANLIB Managed Flexible Fund, for instance. Its strategic objective is to beat CPI by 5% over a rolling 24-month period while avoiding risk of loss over rolling 12 month periods.

Munzara notes: "The public instantly grasped the broad absolute return concept, but specific strategies for achieving inflation-beating returns came in for less scrutiny. In the current environment, scrutiny will certainly intensify."

Many strategies are employed in the sector, but essentially there are two basic models: strategic asset allocation that relies on diversification and taking a long-term view and tactical asset allocation that depends on market timing and may involve recourse to derivatives.

"When equities rise constantly with low volatility," says Munzara, "it would not be overly apparent to the average investor whether good results were a product of skill or luck. Even if calls based on timing were occasionally wrong, the general movement of the market would mask the error.

"When volatility increases, markets are less forgiving and the investor sees the results more clearly."

In the coming weeks, consultant surveys and analysts can be expected to provide insight into the success or otherwise of different strategies.
 
Added Munzara, "We seem to have entered a period when the market is saying 'Will the real absolute funds stand up please?' Identifying the stand-up funds and strategies will be interesting."