Real return funds that can flex their asset allocations to suit market conditions have significantly reduced their equities exposure, according to Zenith.
Among Zenith’s rated universe of real return funds, the average allocation to Australian equities has progressively declined from 13.6% in December 2016 to 4.5% as at June 2018. By comparison, the Australian equities allocation of traditional multi-asset funds rated by Zenith in the growth category has remained relatively steady at 24%. Traditional multi-asset funds have far less flexibility when it comes to asset allocation.
Zenith’s Head of Multi Asset Andrew Yap said “despite Australian equities continuing to rally, real return fund managers have generally reduced their exposures due to the perceived equity overvaluation as well as the potential downside risks stemming from a possible economic slowdown.”
Real return funds generally aim to deliver positive returns above the inflation rate even when financial markets are declining. They invest in a range of asset classes and have a high degree of autonomy in their respective allocations, as they aim to avoid poor performing sectors. In contrast, most other traditional multi-sector funds invest within tighter asset allocation ranges, and aim to outperform a blended asset class benchmark, even if that benchmark declines in value.
The divergence in asset allocations has led to a performance differential opening up between real return funds and their traditional counterparts, particularly over the past three years. Equity markets have continued to rally and real return funds have been conservatively poised, further reducing their equity exposures in expectation of a sell off.
However, over a longer time period, real return funds have generally outperformed traditional multi-asset funds – but only on a risk-adjusted basis.
Zenith’s analysis over five years to June 2018 revealed that while traditional funds in the growth category generated higher performance owing to their persistent higher allocations to equities (8.1% versus 6.1%), in the longer time horizon the smaller capital drawdowns of real return funds play out and have benefited the risk ledger.
The worst drawdown (biggest loss) for traditional multi-asset funds was 6%, compared to just 3.8% for real return funds. When combined in what’s known as a Sharpe Ratio to measure return for risk, real return funds reported a ratio of 1.08 compared to 1.02 for the traditionals. That’s a meaningful difference because a ratio above 1.0 implies sound reward for risk.
Yap explained “the greater capital protection and volatility management of real return funds can be largely explained by their lower equity exposure and willingness to include derivative-based strategies for capital protection. What we’ve found is that in a low return environment, the capital protection performs equally well on any downside but has a more meaningful drag on upside performance.”