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How to invest in absolute return sector funds in falling markets

Investors are nervous and perhaps they have every reason to be. A decade-long bull market appears to be stuttering, global growth is slowing and political tensions are worsening. In such an environment, it can be hard to know where to turn. In the investment companies market, many investors have been putting their faith in a select group of funds with an absolute return focus in the Association of Investment Companies’ Flexible Investment sector. However, these funds are taking different approaches to riding out the oncoming storm.

In the wake of the Global Financial Crisis, central banks slashed interest rates and embarked on a programme of stimulus. The effect was to drive up asset prices across the board, leaving them vulnerable to a correction. The managers of these absolute return funds are faced with a difficult task. Inflation may be subdued but is still present; holding cash could mean accepting negative real returns. The same is true of high-quality government bonds.

Each of these funds retains some exposure to equity markets. JPMorgan Multi Asset Trust (MATE) is at the high end of equity exposure with 59% at the end of May 2019. Next highest is Seneca Global Income & Growth (SIGT), which has been marching down its equity exposure since the start of 2017 and, at the end of May 2019, equity exposure had reached 53% of the portfolio. At the other end of the spectrum are Aberdeen Diversified Income & Growth (ADIG) at 18% and Capital Gearing Trust at 15%.

…The last major asset class is bonds. Here the field divides between those who believe we are trapped for the foreseeable future in an environment of low inflation/deflation and those who fear that inflation may spike. In the latter camp, Capital Gearing, Personal Assets and Ruffer have made sizeable allocations to index-linked bonds, especially US Treasury Inflation Protected Securities (TIPS), of 33%, 31% and 12% respectively.

…Capital Gearing’s managers paint a picture of the US Federal Reserve, faced with an over-indebted and slowing US economy, slashing rates to stave off the nightmare of a sharp rise in defaults only to lose all control over inflation.

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