The Alger Focus Equity fund posted a return over the year of 56.3%, while another of its strategies, the $564m Alger American Asset Growth fund, was up 52.39%.

While surging share prices in Nvidia and other US tech stocks on the back of AI have been among the largest contributors to performance over the last year, the Alger American Asset Growth fund is one of the few actively-managed funds to beat the S&P 500 over a 10-year period.

See also: Yearsley: Financials ‘surprise winner’ of 2024

Speaking to Portfolio Adviser, Alger CEO and CIO Dan Chung says that the firm’s long-term performance is down to a lot more than just holding Nvidia.

Chung is a named manager alongside Dr Ankur Crawford and Patrick Kelly on Alger American Asset Growth, while Crawford and Kelly also run the Alger Focus Equity fund.

“Over a long-term period, its not about a single stock. It’s hundreds of decisions every year, and sometimes the decision is not to sell,” Chung says.

“We were early in Nvidia, buying in 2022. After 2023 saw a spectacular rise in the stock, a lot of people were saying that it must be time to sell, without carefully understanding the fundamentals of the business and how early on we are in the AI revolution. Our biggest and best decision was not to sell any of our Nvidia stock at that time, and it remains a top holding.

“Over the longer term, the success of the strategy has been a relentless focus on the depth and the quality of our team. 60 investment professionals for a firm of our size is actually quite a lot.

“We have a concentration of analysts that is probably 2-3 times more than a lot of our competitors.”

See also: Artemis merges European funds

The firm’s investment approach seeks to benefit from what Chung labels ‘positive dynamic change’. Reviewing the performance of the Alger American Asset Growth strategy over the last 10 years, in which it has posted a 430.8% return (as of 7 January), he says it has been a period of immense change.

“That period started with coming out of the great financial crisis, before entering into the most radical changes in American politics in decades.

“Our relentless focus on our philosophy of positive dynamic change – it means that culturally, as an investment firm, we’re very focused on embracing change. Don’t be afraid of disruption, innovation and volatility. Instead, we look at it as an opportunity to look for the positives that come out of these changes.

“The world is changing faster. There is more innovation and more disruption, which means winners and losers are created faster than they were in the past.

“It’s a highly competitive game. It requires people, but it also requires that right philosophy and mindset.”

European growth

The New York-based boutique is a growth equity specialist, and though it is better known back at home, the firm is looking to expand its offerings in Europe.

“We only have about 5% of our clients internationally — we have a two-person office here in London and a one-person office in Singapore, and we’re trying to grow in both regions.”

“We have been interested in talking with European asset managers in a similar situation, whether we can partner to help them grow in the US, and help Alger grow over here.

“There are some very obvious advantages for a European asset manager to consider partnering with a firm like Alger. We can offer significant US distribution. I’ve met many firms here that are actually quite large and don’t really have any US distribution, and we don’t have significant European distribution. The opportunity is pretty large.”

Industry M&A

The firm, founded in 1964 by Fred Alger, recently celebrated its 60th anniversary.

Industry M&A has seen many boutique firms in both the US and Europe swallowed up by larger asset managers.

However, Chung says that this trend has led to the unique selling points of larger asset managers becoming distorted, which can be exploited by existing boutiques.

“We’ve been taking advantage of the industry structure right now. In traditional asset management, you have a few global giants, and then you have a lot of very big companies just outside of the top 10.

“A lot of them have been created out of multiple mergers. The challenge there is that they don’t have the distribution scale of the largest names, and because they’ve been created out of mergers, a lot of them are like supermarkets. They offer everything, but they’ve lost a little bit of what they are best at.

“They all originally had something that they were really good at, whether it was bonds, equities or real estate, but now that they’ve become these large ‘supermarkets’ – they’re trying to compete with the Costco’s and the Tesco’s.

“They have a lot of challenges because it’s hard for them to grow as they’re large already. Their cultures are just within the team of the investing, and they’re not necessarily particularly known to be particularly at any one thing.”

The combined fund will manage over £330m assets and will be managed by Philip Wolstencroft (pictured).

Wolstencroft, who founded the ‘SmartGARP’ systematic investment process, has managed the fund since its launch in March 2001.

See also: IA: UK reinvests in November following two months of exits

The strategy is a top quartile performer in the IA Europe ex-UK sector over one, three and five years, according to FE Fundinfo data.

Wolstencroft said: “In our fund we own stocks with a historical yield of over 4%, and the growth rate in earnings and cashflows for these companies has been averaging about 7% per annum for the past decade.

“Given that the return from any asset is a function of its yield plus its growth rate, I’m positive on the outlook for the fund.”

The £22.5bn fund rose by 8.9% in 2024, trailing both the MSCI World Index (up 20.8%) and the IA Global sector average of 12.6%.

In an annual letter to shareholders, he said a “longer-term perspective may be useful” and is more consistent with the fund’s investment aims and strategy.

Since inception in 2010, Smith said the fund has returned 2.7% more than the index per year with less downside volatility, with a Sortino Ratio of 0.87 against 0.60 for the index.

Smith said that market concentration made it a particularly difficult year to outperform, with just five stocks making up 45% of S&P 500 returns in 2024.

While US tech giants Microsoft and Meta were the two most positive contributors to performance over the calendar year, the fund’s performance has been hurt in recent years by the performance of Nvidia particularly, which is not in the Fundsmith Equity portfolio.

See also: Alex Game appointed to Liontrust UK equity funds as Julian Fosh retires

“Clearly investors want active funds to outperform all the time, but that simply isn’t possible, especially in current market conditions,” Laith Khalaf, head of investment analysis at AJ Bell, said.

“Indeed the question at present isn’t so much whether Terry Smith is underperforming the MSCI World Index, but whether the index is outperforming Smith and his fellow active managers.

“As detailed in our latest Manager versus Machine report, only 18% of active managers in the Global sector outperformed the average index tracker in 2024 to the end of November, and only 17% achieved this feat over the longer, and hence more substantive, period of 10 years.

“A large part of the strong index performance has been driven by a relatively small number of big technology names, which hold such a high weighting in the index that active managers are unlikely to be anything other than underweight this grouping, known as the Magnificent Seven, as a whole.”

Weight loss drugs impact alcohol stocks

Smith also revealed that the fund has sold its stake in Diageo amid concerns over the impact of weight-loss drugs on demand for alcohol.

Fundsmith has held a position in Diageo since inception.

“We suspect the entire drinks sector is in the early stages of being impacted negatively by weight loss drugs. Indeed, it seems likely that the drugs will eventually be used to treat alcoholism such is their effect on consumption.”

Brown-Forman, one of the world’s larges drinks companies, was one of the largest detractors over the year. Smith said that the stock has suffered from the fall in consumption from the pandemic highs and is “probably seeing early signs of the adverse impact of weight loss drugs”.

However, retaining Brown-Forman “keeps a foothold” in the drinks sector.

Smith added that the shift in consumption habits may lead to a larger bias towards premium spirits, which may help Brown-Forman to negate the impact of weight loss drugs, with consumers potentially drinking less but opting for higher quality.

“It is a company which survived Prohibition so we hope there is literally something in the DNA to help with these adverse circumstances.”

See also: 30-year gilt yields hit 27-year high

The Aegon Sustainable Diversified Growth and Aegon Sustainable Equity funds intend to adopt the label from the end of March 2025 following shareholder notification.

Aegon also confirmed the Aegon Ethical Equity fund, Aegon Ethical Corporate Bond fund and Aegon Ethical Cautious Managed fund will not have UK sustainability investment labels, as they operate exclusionary screens and do not fit within the label categories defined by the FCA. However, they will be in the unlabelled with sustainable characteristics category, which will result in disclosures aligned with the labelled funds to ensure transparency.

Miranda Beacham (pictured), head of responsible investment at Aegon, said: “We are very pleased to see SDR is gathering momentum in providing greater clarity and confidence in the market for our clients and look forward to adopting the new labels for our funds.

“Our ethical franchise, remaining unlabelled with sustainability characteristics, will continue to be entirely unambiguous in its goals, an attractive proposition to some investors looking to align their values and views on responsible investing.

“Indeed, our Ethical Investor Survey – carried out every two years – ensures our funds stay aligned both to these goals, and also with societal changes.”

This story originated on our sister title, PA Future.

Adjusted for inflation, most private client portfolios are at a similar level to 2017, with real returns needing to average 6.6% over the next decade to revert to the historical norm of 4% per year.

Inflation spiralled in 2022, reaching a high of over 11% in the UK before inching back towards the Bank of England’s 2% target over the last 18 months. Meanwhile, returns were also down that year with the MSCI World falling 7.8%.

In 2024, private clients made average nominal returns of 8.4%, compared to the historical average of 6.1%.

ARC collects the actual performance of over 350,000 portfolios (net of fees) from 140 investment managers to establish the returns being seen by real clients.

See also: Calastone: Equity funds pull in record £27.2bn inflow in 2024

Shaun Le Messurier, director at ARC Research, said: “Investors may be relieved to see the value of their portfolios back at pre-2022 levels but it is important to consider portfolio returns after inflation has been taken into consideration.

“Our data shows the extent of the damage caused by the market events of 2022. Despite Steady Growth portfolios, which are the most popular among private client investors, generating above-average real returns for the second consecutive year, these portfolios remain 12% below 2021 levels in real terms – and significantly below the 4% a year real target return.”

The firm recently conducted a sentiment survey of CIOs, which found trade wars, inflation and equity concentration to be among the top concerns in the coming year despite a positive sentiment towards equities.

Following Donald Trump’s US election win in November, fears of potential trade wars and supply chain disruption have grown sharply.

According to the survey of 98 CIOs, there is also a lingering unease about persistent price pressures and monetary policy responses.

According to Calastone’s latest Fund Flow Index, global equity funds were the largest beneficiaries, with £19.5bn of net inflows over the course of the year.

The enthusiasm for equities did not translate to UK equity funds, however, suffering £9.6bn outflows. This marked the sector’s ninth year of outflows and its worst year on record relative to the broader market.

European equity funds posted a record year for flows, pulling in £3.2bn, while emerging market funds enjoyed their second best year on record.

See also: UK retail equity ownership the lowest in the G7 as abrdn urges action

Asia-Pacific also shed record outflows, with the £1.8bn the most the region has seen in a calendar year.

Greater China funds also suffered outflows, while Japanese equities pulled in a record £1.59bn to the sector.

Edward Glyn, head of global markets at Calastone, said: “Global funds are dominated by US stocks already, but the additional focus specifically on that region shows that investors are doubling down on Wall Street. Purchases were very front-loaded in the year, however, and there has been greater wariness as markets have tested new highs.

“A correction in August and a wobbly December for global markets have reminded investors that risks abound. The bond markets are the place to look for these signals. The summer saw fears rise over government deficits and inflation; this has pushed yields in many major bond markets back towards the 15-year highs we saw at the beginning of 2023 – and bond prices lower as a result. Consequently, equities look more exposed, especially in those parts of the world where they have raced ahead.

“That does not include the UK. The UK stockmarket badly underperformed most of its peers in 2024 and this has only intensified the extent to which UK-focused funds are being shunned by investors. The last year to see significant inflows was 2015. Since then, £45bn has been withdrawn from the sector. UK equity valuations are clearly cheap, but investors are capitulating, seemingly giving up hope that a long-awaited re-rating will occur.”

See also: CIOs name trade wars and concentration risk as 2025’s top concerns

Fixed income funds saw inflows drop to £1.3bn in 2024, down considerably from the £7.7bn that flooded into the asset class in 2023. Flexible bond funds particularly suffered, with investors pulling £3.35bn from the sector.

Bond market weakness aided money market strategies, which had their best year ever with £1.86bn inflows.

Mixed asset funds also enjoyed their strongest year since 2021, enjoying inflows of £14.6bn.

By style, passives dominated with £29.6bn inflows. Investors redeemed £2.4bn from active funds over the year.

Some British companies such as Gamma Communications, 4imprint and CVS appear in the top holdings of a number of UK small-cap funds, despite it being a broad investment universe. Not to mention, each of these companies have a market cap in excess of £1bn – not the price range most people have in mind when they picture smaller companies.

In the Rockwood Strategic trust, manager Richard Staveley will only invest in companies below £250m to keep the focus on this lower end of the market.

He says: “This industry can sometimes not think about the real world. They are telling the truth in that they are the smallest companies in relation to the largest ones. But in the real world, they are not really small.”

See also: UK small caps: Depressed for a reason, or at the cusp of a multi-year supercycle?

Indeed, the definition of what a smaller company is can vary considerably from manager to manager.

“There is no agreement on what small is – it is all relative. I don’t think there is a mis-selling scandal here, but funds must be transparent about the average size of the companies they are invested in.”

A shrinking market

A key reason why these funds have ended up holding the same stocks is because the number of smaller companies in the UK is shrinking. Valuations were spread more evenly across the market when the Numis Smaller Companies index first launched in 1987, but widespread M&A activity has meant much of the wealth is now concentrated in fewer names.

For example, the largest company in the bottom 10% of the market was worth £108m in 1987. Today, that same company has a market cap of £1.7bn.

To read more visit the February edition of Portfolio Adviser Magazine

One of the largest holdings in the $37.9m (£29.8m) Antipodes Global fund, which contains 75 stocks – is a large-cap pharma name which isn’t dependent on popular weight-loss drugs.

Alison Savas, investment director at Antipodes Partners, has high conviction in Sanofi, a leading immunology healthcare firm headquartered in France.

“Its strengths lie in that it does not face any patent risk this decade, it has a much lower exposure to US drug pricing risk than peers, a deep pipeline, a dominant vaccines business and a leading consumer healthcare business that it’s in the process of monetising,” Savas told Portfolio Adviser.

It hasn’t all been smooth-sailing for the multinational company, however; Sanofi’s share price fell by more than 20% last year after it pledged to increase its research and development (R&D) investing by 10% to €7.7bn (£6.4bn) annually during 2024 and ’25.

Savas said prioritising pipeline development over short-term earnings growth “spooked the market”, although her team used this as an opportunity to increase the fund’s exposure.

“Central to Sanofi’s investment thesis is a pharma portfolio that isn’t facing patent cliffs. It has an emerging powerhouse on its hands with Dupixent, used to treat allergic diseases such as dermatitis and asthma, currently generating around €13bn in annual revenue and outperforming market expectations,” she explained.

“Despite its size, Dupixent can see low double-digit growth per annum into the next decade due to greater penetration of existing indications, younger age groups, new geographies and a recent approval to treat chronic obstructive pulmonary disease or COPD (chronic bronchitis) – a large additional patient population.

“This is not properly reflected in analyst forecasts,” Savas said.

What is even more appealing, according to the investment director, is that the company isn’t solely dependent on the success of Dupixent. It also holds business of so-called “orphan drugs”, used to treat rare diseases, which are typically high-cost but high-profit.

“Combined with exciting new launches, these account for an extra €7bn in revenue, growing at a high single-digit pace.

“On top of this Sanofi has a full pipeline focused around its key areas of strength. Any positive readouts in 2025 will increase the market’s confidence in the pipeline and vindicate the decision to pivot strategy. A solid balance sheet also leaves room for acquisitions to further bolster its pipeline.”

Elsewhere, Savas said Sanofi’s €7.5bn vaccines business is growing faster than market expectations.

“Vaccines are a sticky, long-duration business with high barriers to entry due to stringent approval requirements and scale manufacturing. Sanofi is one of three scale providers of the flu vaccine, with polio and meningitis vaccines also in its stable.

“Particularly promising is the new RSV vaccine, which targets a virus that can cause severe respiratory infections, particularly in children. Expanded production capacity positions Sanofi to meet rising demand, adding another growth driver.”

Finally, she referred to Opella – Sanofi’s consumer health business – which recently attracted a €16bn private equity deal, with Sanofi retaining a 48% stake. The division predominantly offers household-name, over-the-counter treatments and supplements.

“Once finalised, the transaction could unlock capital for share buybacks or strategic investments – moves likely to be rewarded by the market,” Savas said.

“At 12x earnings, with earnings forecast to grow around 10% per annum, there’s a lot to like about Sanofi. While the share price has regained almost all it lost on last year’s R&D announcement, there are multiple catalysts coming over the next 12 to 24 months that can drive the shares higher.”

Handbags and gladrags

Luxury goods companies such as L’Oréal in cosmetics and LVMH in fashion have proven resilient despite a global deceleration in consumer spending globally, according to Ben Peters, fund manager of the Evenlode Global Income fund.

But while revenue for the likes of these names has continued to rise, growth has still slowed on a relative basis, which the manager said has led markets to mark down the share prices of some firms “quite significantly”.

“We have responded by growing these positions over time. We have increased L’Oréal from 2.7% of the portfolio at the start of the year to 3.8%, and LVMH from 2.8% to 3.3%,” he explained. “As their stock prices are down by 20% and 13%, respectively, in sterling terms over the year so far, valuations look good in an absolute and a relative sense.”

Peters said famous fashion houses stand the test of time and avoid the cyclicality of lower-budget brands.

Because luxury brands are perceived to be higher quality, more durable and therefore more valuable than their non-luxury counterparts, the manager believes they offer “resilience in the event of an economic downturn”.

“We have held LVMH for some time, and Richemont has also recently been under our microscope although has not yet made it into our investable universe,” he said.

“Both companies are ‘houses of brands’, in other words a collection of well-diversified luxury businesses serving multiple end markets. For example, half of LVMH’s income derives from fashion and leather, with the other half coming from perfumes, watches and alcoholic beverages, among others.”

In contrast, Richemont focuses predominantly on luxury jewellery and watches, with Cartier one of its leading brands, although it also has a smaller segment offering luxury clothing and apparel.

“Richemont operates somewhere between LVMH and Hermès in terms of the tier of luxury goods it sells,” Peters explained. “Its jewellery brands and watch portfolio is undoubtedly in the very top tier of luxury goods, by both price and reputation. Its soft luxury brands, on the other hand, may not be quite as high tier when compared with their rivals in the space, and they are getting out of the online market business by selling Yoox Net-a-Porter (YNAP), an acquisition that never really got going.

“Additionally, the jewellery segment of luxury remains quite fragmented, providing opportunities for further consolidation where, YNAP aside, they have historically proven to be shrewd operators in M&A.”

Despite short-term headwinds, the manager is positive on the prospects for the luxury segment.

“On balance it seems unlikely that high-net-worth and aspirational wealthy consumers will eschew handbags and gladrags any time soon. Exactly where around the world the growth is driven from may change though, making a multinational approach appealing.

“While consumer spending could remain soft in the short term, the valuations at which some luxury companies are trading relative to history offsets these challenges.”

Learning curve

Education has long been preached as an investment in the next generation by parents and teachers alike, and for Steven Tredget, partner at Oakley Capital, it’s a valuable part of the portfolio.

“Education is a subscription,” said Tredget. “It’s one of the last things you will change, if you can avoid changing.”

From an investment perspective, this means a steady stream of income that is able to withstand economic wobbles. Tredget saw the opportunity to combine the longstanding success of education with technology, by investing in the mainly online university IU Group.

The German private university was founded in 2000 and targets a different group of students than a traditional university. “The average age of an IU group student is 27, and 70% of them do not come from a family background of higher education,” he said. “They’re in work or have families, and so they are looking to study on terms that suit them. These are highly modular degrees, so you can create one to suit you. Often people choose professional-type bachelors based on the fact they’re already working and want something quite specific.”

The university is now the largest and fastest-growing in Germany, with more than 140,000 students enrolled. Tredget believes some of this success is due to the business model, which is not focused on research or attracting international students, but on offering a service to its consumer.

“This is like any customer service. It’s asking what customers value and focusing on that output. What they typically value is the outcomes of degrees,” Tredget said.

“The average salary increases by 20%, and now their degree time is shortening as well.”

Recently, this has been aided by the launch of an AI teaching assistant, called Syntea, which has cut the time it takes to complete a degree by almost a quarter.

“Students will ask 10 times more questions of Syntea than they would a physical professor, because she’s always available. Second, they’re not embarrassed to ask the stupid questions, and so Syntea learns much more about the student,” Tredget said.

Oakley first invested in IU Group in 2018, when the university was operating at a much smaller scale. When the investment came to fruition, it was too large for Oakley to remain the sole control investor. Oakley now has the holding in a continuation vehicle alongside a group of other investors.

It’s a story that’s not uncommon for Oakley, which invests primarily in companies that are not yet large enough to be considered by large-scale private equity firms. Tredget said the firm often works with companies that are diving into the world of private equity for the first time, with some deals taking years to build trust with the owners.

“It’s too much hassle for the larger firms to come down that far,” Tredget said. “We don’t tend to find much competition. Three quarters of our deals are outside the auction process, so they’re a bilateral conversation between us and the founder.”

This article first appeared in the December issue of Portfolio Adviser magazine

Government debt has risen to all-time highs during the past decade, but the opposite can be said for the average UK consumer. Household debt peaked at 156.4% of disposable income in 2008 and has been in steady decline ever since, dropping to 121.3% by the second quarter of this year. It was a notable burden on growth at the time, with household debt representing 95.4% of gross domestic product in 2008, but this figure had fallen to 78.8% by the start of 2024.

The debt crisis following the global financial crash in 2008 was a clear catalyst for this decline. Consumers naturally became more cautious, according to Hewitt, yet the scrapping of interest rates had a far bigger impact on their relationship with borrowing. Without interest rates, consumers could continue to take on debt – perhaps even more than before the credit crunch – but could pay it off easier.

Hewitt says: “The financial crash had many long-term repercussions. People were unwilling to take on new debt and keen to pay down existing debt. But it is important to remember that interest rates went to virtually nothing. People found paying off debt wasn’t as expensive as it once was. So while government debt has exploded on the upside, household debt has gone the other way, and I think this will continue now interest rates are higher again.”

Return of the rates

After more than a decade of zero interest rates, central banks around the world – including the Bank of England – set new highs in 2021. And while rates have lowered slightly this year, economists anticipate a tighter monetary environment for years to come. That means new debt will be a lot harder to pay off, so will we see household debt bounce back?

Apparently not, according to Hewitt, who believes UK consumers will be averse to taking on new debt if it is more expensive to pay off. And this won’t come at the expense of consumer spending, with UK households sitting on double the amount of savings they held before Covid – they had £143bn squirreled away before the pandemic, but that has rocketed to £338bn today, Hewitt adds. Thanks to these higher savings and lower debt, consumer spending has been steady.

Income on the rise

Another factor driving the lowering of household debt has been wage growth, notes Hewitt. People in the UK have increased the volume of borrowing since 2008, but it is a smaller proportion of household income as salaries have risen. Average weekly earnings are up 46.7% over the past 10 years, to £646, according to the Office for National Statistics, making paying off debt less of a burden.

And recent moves by chancellor Rachel Reeves to increase the national minimum wage to £12.21 an hour could further boost household income, says Hewitt. Though he notes other decisions in Reeves’ first budget could hinder growth, namely the £20bn employers will be spending on National Insurance“It may not be quite as bad for companies if the top line grows,” he explains. “Consumers’ savings are still full, their wages are rising and debt is down – in other words, there is plenty of money to spend.”

Despite this favourable backdrop, UK consumers have been reluctant to spend in any meaningful way. Though it remains elusive as to what will trigger UK consumers to splash out, Hewitt says “all the fundamentals are pointing the right way”.

This point is echoed by Cassie Herlihy, associate director for public equity at Gresham House: “We like businesses with strong balance sheets because they can withstand shocks –and that same principle works for the consumer.”

These strong foundations have led Hewitt and Herlihy to favour small and mid-cap companies, which are primed to benefit from this due to their high exposure to the domestic UK market.

This article first appeared in the December issue of Portfolio Adviser magazine

Following Donald Trump’s US election win in November, fears of potential trade wars and supply chain disruption have grown sharply.

According to the survey of 98 CIOs, there is also a lingering unease about persistent price pressures and monetary policy responses.

Meanwhile, overvaluations and dominance of a few sectors or companies could create potential systemic risks.

See also: Yearsley: Financials ‘surprise winner’ of 2024

Dr James Cooke, deputy CIO at ARC, said that many of the risks are interlinked.

“Trade wars combined with a China slowdown could lead to heightened Taiwan tensions which would lead to fears over advanced node semiconductor manufacturing, which in turn would impact many of the Magnificent Seven. Inflation rising too much could force central banks to tighten monetary policy more aggressively and the money supply is a significant detriment to the return on risk assets.

“On the brighter side, there continues to be rather a lot of cash in money market funds or ‘dry powder’. We would not be too surprised to find 2025 is a year of heightened ‘animal spirits’ and increased M&A activity which tends to be good overall for equity prices, particularly of slightly smaller companies. Perhaps this means we will actually see the broadening out of equity markets that many managers talked about around this time last year.”

Despite the concerns around market concentration, the net sentiment towards equities has increased to 56%, up from 21% over the past 12 months.

However, the ARC survey found that sentiment towards both UK and European equities has fallen, while CIO enthusiasm for bonds has also waned over the last quarter.

Many funds in the IA Targeted Absolute Return sector put capital preservation centre stage, sharing the ultimate goal of delivering positive returns in all market conditions. This presents an appealing prospect for many investors, yet the sector has been brought into disrepute by poor performance from its flagship fund – abrdn’s Global Absolute Returns Strategy (Gars).

The strategy held a colossal £53bn in assets under management (AUM) at its peak in 2016, but dwindling returns in the ensuing years led it to close down in 2023 at just £1.4bn. The sector as a whole has suffered consecutive monthly outflows since April last year, losing £2.5bn in total over the period.

But Mike Pinggera, head of multi-strategy at Sanlam Investments, says that “while the sector suffered reputational damage in the wake of Gars, it would be a mistake to write off its potential entirely”. Some tiny funds have continued to deliver strong returns despite investors withdrawing cash from the sector en masse, yet remain relatively overlooked compared with their larger peers.

VT Woodhill UK Equity Strategic

Fund size: £29m

VT Woodhill UK Equity Strategic’s AUM of just £27m seems minute when measured against the £545m of an average IA Targeted Absolute Return portfolio. But despite its small size, a total return of 27.4% over the past three years was far greater than the peer group’s 10.1% gain during the period – although it should be noted that the sector is highly diverse and so sector comparisons are not foolproof.

Manager Paul Wood invests in UK companies he deems able to “protect investors’ capital when the market falls, and add value as it rises”.

Top holdings include British stockmarket staples such as Shell, AstraZeneca and HSBC, which together account for one-fifth (20.4%) of the 58-stock portfolio. These shares also pay reasonably high dividends, contributing to the fund’s overall annual dividend yield of 3.9%.

Its capital-preserving strategy has certainly proved effective, delivering positive returns on investors’ savings in 26 of the 36 months throughout the period. In poor market conditions, it also protected capital against the worst downturns with a max drawdown of just 2.6%..

These characteristics could give portfolios some much-needed protection in coming years if markets remain volatile, according to Pinggera. “As we move into an era of heightened market volatility, interest rate uncertainty and changing economic conditions, absolute return strategies offer a compelling way to navigate these challenges,” he says.

“While the past performance of some funds may have disappointed, today’s investors should evaluate absolute return strategies within the context of modern markets where volatility and risk management are more important than ever.”

Polar Capital Global Absolute Return

Fund size: £77m

Another fund that has delivered strong returns during the past three years while also protecting against downturns is Polar Capital Global Absolute Return. It is up 20.3% over the time frame after doubling the 10.1% return made by the average IA Targeted Absolute Return fund.

Managers David Keetley and Stephen McCormick have run the fund since it launched at the end of 2018, building a portfolio of 50-100 positions across asset classes and regions worldwide. Most of its long equity exposure comes from the US, making up 34.7% of this sleeve of the portfolio.

Pinggera notes that while the downfall of funds such as Gars “undoubtedly shook confidence” in absolute return strategies that ultimately “tarnished the reputation of the sector” as a whole, portfolios such as this one are well worth revising.

“The lessons learned from past missteps, combined with improved transparency, risk management and a dynamic economic environment, suggest the sector is well-positioned to offer value to investors seeking diversification and uncorrelated returns,” he says.

“For those seeking an all-weather investment strategy, it might be time to take another look at the IA Targeted Absolute Return sector.”

M&G Global Target Return

Fund size: £58m

One tiny outperformer that may have gone unnoticed is the M&G Global Target Return fund. It climbed 18% over the past three years, outshining the peer group average by 7.9 percentage points, despite being just £58m in size.

Manager Tristan Hanson and deputies Craig Simpson and Aaron Powell invest in different asset classes around the world, with UK government bonds making up the top 17.3% of the fund.

This article originally appeared in the December issue of Portfolio Adviser magazine

The performance gap has been magnified in global and US funds, as the magnificent seven drives returns for indices. Only 17% of global funds outperformed the passive alternative in this year’s research, the worst reading since AJ Bell began the report in 2021.

However, even in markets that haven’t enjoyed the magnificent seven boost, such as the UK, active funds haven’t managed to find the edge. In 2024, just 35% of active UK funds beat out passive.

See also: The 18 UK stocks outpacing the S&P 500

Laith Khalaf, head of investment analysis at AJ Bell, said: “Make no mistake, passive funds are eating the lunch of active managers, and the continued strong performance of index trackers will do nothing to staunch this trend.

“Whether you look at the short term or zoom out and take a wider perspective, the picture remains dismal for active managers, and it’s the influential Global and North America sectors where a lot of the damage is being done.”

Without factoring in US and global funds, 44% of active funds were able to outperform the index across ten years. Japan and global emerging markets were the only two sectors where the majority of active funds outperformed passive across a decade, at 52% for each. In the past five years, no sector has had a majority of funds beat the passive alternative.

“The long-term performance of tracker funds in the key US and Global sectors has been nothing short of astonishing,” Khalaf said.

“The idea that a plain vanilla US tracker fund could quadruple your money in a decade would have been beyond the wildest dreams of all but the most overconfident investors. Yet that is precisely what has unfolded in the last 10 years. Indeed, over just the first 11 months of 2024, the average US tracker returned 27.6%.”

The pattern of underperformance has started to take a toll on flows. In the past three years, active funds have experienced outflows of over £100bn. While passive funds have pilfered some of this cash flow, a net £56bn has been withdrawn across all open-ended funds across the last three years. ETFs, bitcoin, investment trusts, expenditure, mortgages and savings in cash also act as competitors for active funds, Khalaf noted.

“It’s reasonable to suppose that the surge in passive fund sales must end somewhere, but we may still be a long way from that point. Trackers currently make up 24% of funds run by Investment Association members,” Khalaf said.

“But in the US, the value of assets in passive funds overtook active funds for the first time last year, according to Morningstar. In other words, more than 50% of fund assets were invested passively. The index investing megatrend began in the United States, so it sets a meaningful roadmap of where the UK investment industry may end up. In other words, don’t bet the house on a revival in active management anytime soon.”