As they attempt to refine and expand their investment options, trustees and plan sponsors are reconciled to the search for alternative ways of producing positive returns while maintaining the required risk profile. One method of generating more alpha from a portfolio is to look at some of the more esoteric investment areas or specialisations. This could be anything from specialist sectors such as health or global resources to works of art. In the European offshore funds marketplace, there are a variety of alternatives (which don’t yet extend to the art world, unfortunately) and some of these offer genuine diversification.
There are a number of issues to be dealt with when looking to allocate to a niche type of asset. Particular attention needs to be paid to the liquidity of the underlying market. Naturally, pension funds do not have to be overly concerned with short-term liquidity issues, but in the context of investment via mutual funds, the issue of liquidity can have a dramatic effect on the dynamics of the investment fund itself.
Prospective investors also need to study the relative volatility of the asset class and of individual funds within the asset class. Performance records have, in many cases, been so patchy in recent times that it is more important than ever to step closer and analyse the quality of the fund management process and the resources at the manager’s disposal. In studying peer group funds for this article, the divergence of performance within an asset class also indicates the wide range of styles being adopted. Part of the puzzle is working out how much of a manager’s performance was attributable to stock selection at a key moment for the markets and to what extent this was luck or good judgment by the manager.
Another indication of the divergence of investment strategies is the adoption of a wide variety of benchmarks, many of which are sub-sets of a recognised index. And peer group comparison is potentially problematical because of the lack of information on comparative portfolio composition. It would appear there are only a few funds that offer real diversification and the prospect of positive returns.This article looks at a number of the options in the European offshore funds universe, excluding hedge funds, which can be used typically as satellite holdings.
The objective of a managed currency fund is to provide investors with protection of real asset values in terms of their base currency and, so far as is compatible with this, to achieve a high rate of return through the management of both the maturity profile and the mix of currencies within each fund. The asset profile is based upon the fund managers’ views of future interest and exchange rate movements.
These funds hold positions in various currencies with the objective of achieving incremental returns by reference to currencies which appreciate in value relative to the base currency. When it is considered that other currencies are likely to appreciate vis-à-vis the dollar, then part of the assets of the fund will be invested in those currencies.
The one-year chart (Figure 1) shows more clearly how each fund has distinguished itself. In particular, it demonstrates how the performance of the AHL and CIBC funds diverged in the second half of the year, with the CIBC Fund showing far less volatility.
The five-year chart (Figure 2) paints an entirely different picture, with the CIBC fund clearly having suffered from exposure to currencies in collapse, including the Thai baht and the Indonesian rupiah. The AHL Currency fund looks a lot more stable over five years, as does Fidelity’s Japanese Yen Currency Fund. The remainder of the funds in this sector produced little more than single-digit returns.
Commodity and global resources funds
Managed commodity funds for institutions are run by commodity trading advisers (CTAs). They employ a variety of strategies often involving futures, options and OTC derivatives. For this reason, it has been difficult to devise a passive benchmark for CTA performance that can be used in the same way as mainstream equity and fixed income portfolios. Of the offshore equity funds investing in commodity stocks, there are two with a long-term track record, the ABN Amro Global Resources and the ING Baring GUF Global Resources Fund. Barings’ John Payne places particular emphasis on the fund’s ability to benefit from the lack of correlation between the different commodity cycles. The emphasis on companies that produce, process and distribute natural resources also allows the fund to take advantage of increased volume demand that is not so reliant on commodity price cycles. Payne is supported by a team of dedicated investment managers who specialise in resource-rich areas such as Australia, Canada, Russia, Africa and South America. The performance of both these funds is very much dependent on timing. Each manager could claim to have done well in key discreet periods. But over the past three to five years, the ABN Amro fund in particular has traded up and down sharply, but at the end of the period is back where it started.
The reason some sector specialist fund managers like energy stocks is because they offer the ability to benefit from the sharp price moves. As a result, the NAV of a fund can fluctuate 5% in a single day, which is perhaps not the sort of volatility you are looking for. Stocks of smaller companies in the oil and gas industry have high growth potential driven by a variety of factors, including changes in oil prices, supply and demand, and whether or not drilling yields favourable results. Exploration and production stocks benefit from rising energy prices and/or further industry consolidation. Integrated companies are exposed to higher oil prices and improving refining margins. Equipment and services stocks can benefit from the growing spend on exploration.
Fund managers report a fundamental shift in the energy industry, with major oil producers planning to increase capital expenditures, with much of the earnings growth emanating from oil exploration companies. However, the threat of a double-dip recession in the US would be symptomatic of a slow down in demand. So while no new oil is being made, the demand side of the equation can decline as well.
Investec’s GSF Global Energy Fund, run by veteran fund manager Tim Guinness, provides access to a mix of oil, gas and alternative exploration, production and service companies. Performance, relative to the MSCI Energy & Resources indices, rests heavily on Guinness’s understanding of the dynamics of the energy industry. Returns tend to be volatile but the fund has proved itself capable of capturing the rising cost of energy. Its three-year track record is well ahead of comparably rated funds such as Merrill Lynch’s Energy International Fund, which had a horrendous period in mid-2001 and Schroder’s Energy fund (Figure 3).
There have been a number of reports recently suggesting that pension and life insurance funds are increasing their exposure to commercial and residential property as they chase the higher and reasonably secure yields. With current yields of around 7%, it is considered a better investment than a bond and certainly a lot more secure than the equity markets. Property has outperformed the equity markets by around 25% over the past five years.
And with near-term returns from equity markets still uncertain, this trend is like to continue. The performance of Asian property portfolios is included within the five-year chart (Figure 4) just to illustrate the relative volatility over the period. The overall return for the Morgan Stanley Sicav Asian Property Fund over five years is –20% compared with +21% for US property and 17.5% for European property. Another fund worthy of consideration is the Henderson HF Pan European Equity Fund.
A fund type for the times, driven by rising incomes and expenditure, the use of technology as a strategic business tool and increasing globalisation of leisure spending. Unfortunately, that was another time. There are six funds in the S&P sector and only two with a three-year track record. Invesco GT Leisure has a minus 5% return over three years to the end of July, while Pictet GSF Leisure Portfolio has produced a negative 44% return. You get the picture; until we see a return to something like the growth experienced in the 1990s, this particular niche is unlikely to be on the radar. Returns for all the funds over one, six and 12 months are all in the red.
The element of gearing is crucial to the attraction of warrant funds, as is the stock-picking ability of the fund manager. Warrant funds provide a geared play on individual equity markets. In the offshore funds universe this amounts to three market segments; Europe, Japan and Asia. The investment style of these funds is growth-oriented, with a focus on companies that are capable of delivering strong earnings growth regardless of the prevailing economic conditions. Invesco European Warrant has been a favourite punt for fund industry folk who wanted a geared play on the markets. But for anyone who has bought it and left their money in, the fund has been another absolute disaster over the last three years. The two funds offering warrant exposure to the Asian markets have produced similarly dismal results. Jardine Fleming’s Japan Warrants fund, has over three years to end-July 2002 produced a negative 63% return. Schroder’s Far East Warrant Fund has managed to limit the losses to single figures this year but over three years the result is –43%.
The five-year return chart (Figure 5) shows clearly that, despite the claims to be able to perform in whatever conditions prevail, the time to be investing in warrant funds is when the market is a racing away. If you wanted a signal that the bull market had come to an end, the performance of European and Japanese warrant funds at the end of the 1990s was a fairly strong one.
Again, because this fund sector is to some degree contrived, some of the benchmarks are modified versions of leading indices. Fidelity’s Consumer Industries Fund, for example, is set against a FTSE Global Consumer sectors modified cap weighting. ING’s Shopping Fund is benchmarked to the MSCI Merchandising Index. The index universe has around 85 stocks and has no exposure to the emerging markets assets class.
The diversity of the sector is arguably an advantage because it should give a fund the ability to perform well through different stages of the economic cycle. The strength of consumer demand has been one of the redeeming qualities of the US economy during this turbulent period for the markets. But this is not reflected in the returns from consumer related funds. There are 10 consumer, media and shopping related funds in the S&P universe, but none has a three-year performance record. The pick of the bunch is probably the Share Consumer Staples Fund, which does at least outperform its peer group and limit the downside.
These funds offer the opportunity to achieve capital growth through investment in healthcare and medical services and product companies worldwide. The funds invest in producers of pharmaceuticals, biotechnology firms, medical device and instrument manufacturers, distributors of healthcare products, care providers and managers and other healthcare service companies.
The Framlington fund’s weak performance this year (down 40% to end-July) is attributable to the downturn in the biotech sector. Another fund worth considering is the Pharma/Health fund run by Bank Oppenheim. The fund takes long term positions in what it considers to be the most promising companies in the healthcare sector, on the basis that success for these companies often comes after an extended period of time. Oppenheim’s mutli-adviser approach enables it to maintain a wide-ranging portfolio of around 150 stocks.