A SIMPLE GUIDE to ABSOLUTE RETURN FUNDS (Continued) (BGB 10Pt)

A SIMPLE GUIDE TO ABSOLUTE RETURN FUNDS (continued) (BGB 10pt)

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Absolute return funds aim to deliver a positive (‘absolute’) return to investors regardless of whether the wider market in which they invest rises or falls. Please remember that absolute return funds do not guarantee positive returns. Performance will be impacted by market movements and the investment decisions made by the fund manager. Absolute return investing can apply to many asset classes and a number of techniques, but this guide focuses on funds invested in company shares (‘equities’) using a ‘long/short’ approach. By speaking to a financial adviser, you can discuss whether investing in absolute return funds may be right for you.

How does absolute return investing differ from traditional The manager of such a fund is likely to build a portfolio of companies investing? that differs to a greater or lesser extent to the make-up of the index, but Traditional investment funds buy shares in companies that the fund the fund will broadly rise and fall in line with that wider index. The manager believes will rise in value. Their success (or otherwise) is drawback of this approach is that if the index is falling, the fund may do typically measured against an index of companies in the region where better than it on a ‘relative’ basis but still lose an investor money in they invest, known as a ‘benchmark’. ‘absolute’ terms.

For example a UK equities fund may be benchmarked against the An absolute return fund seeks to do things differently. Instead of being FTSE All-Share Index or a European equities fund against the MSCI measured against an index, it aims to deliver positive returns regardless Europe Index. These funds are said to be managed on a ‘relative of whether equity markets are rising or falling. With this aim in mind, return’ basis, which means they aim to deliver returns above those of, absolute return funds tend to be benchmarked against the return or ‘relative to’, their benchmark. See the chart below for an example. available from holding cash on deposit. See the chart below for an example.

Relative return example Absolute return example

25 Example fund 20 Example fund Equity benchmark index Cash benchmark 20

15 15

10

5 10 eturns (% ) eturns (% ) R R 0 Time -5 5

-10

-15 0 Time A SIMPLE GUIDE TO ABSOLUTE RETURN FUNDS

How does absolute return investing work? What are its benefits and drawbacks?

The managers of absolute return funds can make money from shares in Absolute return funds can help diversify a portfolio of companies that go down as well as up. This is often referred to as a relative return funds. Mixing different fund types can ‘long/short’ strategy. spread risk, with different approaches generating returns in different ways and at different times. This A ‘long’ position is when a manager buys shares in means that while one approach may be performing a company (or index of companies), expecting them badly, another approach may perform well – the net result can be less to rise in value. This is how a traditional relative volatile (see glossary) overall returns. Therefore, investing in absolute return fund invests. return funds can provide a different way of generating returns from stockmarkets and potentially reduce the risk to an overall portfolio of funds. A ‘short’ position is when a manager takes a position on what they believe to be an overvalued A principal drawback is that when the value of a market company (or index of companies), that allows a in which an absolute return fund invests increases profit to be made if its share price falls. The risk is rapidly over a sustained period, the fund is unlikely to that if the manager wrongly predicts a fall in price, deliver the same high return as a relative return fund. the position will lose money. They can, however, deliver a steadier rate of return over the long term. So returns depend on the manager’s ability to correctly pick the stocks that will rise and fall in value.

In using an absolute return strategy, a manager has a wider range of tools than a traditional ‘long-only’ manager. These include derivatives (see glossary), which are financial instruments for which the price is derived from one or more underlying assets – in this case, shares. Short positions are achieved through derivatives. Derivatives are more complex than shares and the manager can use them to increase or decrease the risk being taken. So investors in absolute return funds need to be comfortable with the extra tools the manager can use.

An overview: relative return vs absolute return funds

Relative return fund Absolute return fund

Aims to outperform the market, In a falling market Aims to deliver a positive/neutral return which could mean delivering a negative return

In a rising market Aims to outperform the market Aims to deliver positive returns

Aims for significantly lower volatility than the market Volatile conditions Closely mirrors the volatility of the market over the long term

Aims to outperform a benchmark index Aims to deliver a positive return regardless Performance target – eg. FTSE 100 Index of whether the market is rising or falling What to look for when choosing an absolute return fund Glossary Correlation: How far the price movements of two variables (eg, Because absolute return funds have different investment equity or fund returns) match each other in their direction. If objectives to relative return funds and use derivatives, variables have a correlation of +1, then they move in the same they require their managers to have more skills if they direction. If they have a correlation of -1, they move in opposite are to succeed. So it is important for you to assess the directions. A figure near zero suggests a weak or non-existent fund manager’s ability to deliver absolute returns in a relationship between the two variables. variety of market conditions and control risk effectively. In doing so, managers should be able to enhance a Derivative: A financial instrument for which the price is derived from portfolio’s risk-return characteristics (the amount of one or more underlying assets, such as shares. It is a contract expected return for a given level of risk). between two parties. It does not imply any ownership of the underlying asset(s). Instead, it allows investors to take advantage of The key characteristics of a successful equity absolute return fund are: price movements in the asset(s).

• correlation to equity market movements actively adjusted (low or Long position: A security that is bought in the expectation it will rise negative correlation during falling or uncertain periods, higher in value. correlation during rising markets). Short position: Fund managers use this technique to borrow then • low volatility relative to equity markets (large price swings in equity sell what they believe are overvalued assets, with the intention of markets are not strongly reflected in fund returns) over the long term. buying them back for less when the price falls. The position profits if the security falls in value. Derivatives can be used to simulate a short position.

Volatility: The rate and extent at which the price of a portfolio, security or index, moves up and down. If the price swings up and down with large movements, it has high volatility. If the price moves more slowly and to a lesser extent, it has lower volatility. It is used as a measure of the riskiness of an investment.

Glossary Please see HGi.co/glossary for a glossary of financial terms used in this document.

At a glance

3 Absolute return funds aim to deliver a positive return regardless of market conditions

3 The use of ‘short’ positions allows a profit to be made if the value of a stock or index falls

3 A successful absolute return fund should have low volatility relative to equity markets with correlation to equity markets actively managed

3 An absolute return fund is likely to underperform a relative return fund when stockmarkets are rising strongly

3 Managers of absolute return funds use more complex instruments and techniques to manage risk

By speaking to a financial adviser, you can discuss whether such an investment may be right for you. Other educational guides in this series include:

A SIMPLE GUIDE TO EQUITIES A SIMPLE GUIDE TO BONDS (continued) (BGB 10pt) Equities (continued) (BGB 10pt) Bonds Published May 2017 Published May 2017

Equities... shares... stocks – in the financial markets they mean the same thing: slices of Bonds are debt securities issued by companies, governments and the like. For investors, they company ownership. In this guide we explore their structure, why their prices go up and down, can provide a stream of returns. In this guide we explore their structure, why their prices go up and some of the key benefits and drawbacks of investing in them. By speaking to a financial and down, and some of the key benefits and drawbacks of investing in them. By speaking to a adviser, you can discuss whether investing in equities may be right for you. financial adviser, you can discuss whether investing in bonds is right for you.

What are equities? A company may choose to raise money for a number of reasons. For example, it may want to expand its operations, invest in research and HGi.co/equities What are bonds? HGi.co/bonds development, or reduce its level of debt. It may even be starting out and need money to form the initial business. A company can do this by splitting Please see Please see A bond is an IOU, typically issued by a government or company (an ‘issuer’). When issued by a company, they are referred to as ‘corporate bonds’. its ownership into ‘shares’ and selling these to ‘shareholders’. It typically offers them on the stock market, where investors can buy and sell them. By buying a bond you are lending the issuer money. Two things are specified at the outset: the agreed rate of interest that the issuer must pay you at regular intervals (the ‘coupon’), and the date at which the issuer must repay you the original amount loaned (the ‘principal’).

To illustrate this, let’s take a fictional bond issued by Enterprise Inc. Say you buy Enterprise Inc’s €100 five-year 5% coupon bond. This means you lend the company €100 and in exchange Enterprise Inc. will pay you an annual coupon of 5% (i.e. €5), and repay the principal after five years.

€ 120 €105

100 Coupon payment Principal for a simple guide to absolute return funds 80 for a simple guide to bonds 60

40

20 €5 €5 €5 €5 0 Year 1 Year 2 Year 3 Year 4 Year 5 For illustrative purposes only

What affects the price of bonds? Bonds can be bought and sold in the marketplace. Their prices change constantly because people in the market make different assessments on two main factors: the likelihood that the issuer will repay its debts (‘credit risk’), and the effect of interest rates (‘interest rate risk’). We say more about these later. In return for buying equities the shareholders become part-owners of the company. Their level of ownership depends on how many shares they purchase. Shareholders have the potential to receive a share of the company’s profits and the right to vote on how that company is run. Their If more investors want to buy a bond than sell, the price normally increases. Similarly, if there are more sellers than buyers, the price normally goes interests at the company are protected by the Board of Directors they elect. down. The rising or falling price affects the yield of the bond. Yield is a way of measuring the attractiveness of an individual bond. However, bonds are not always held until the principal is repaid - they can be bought and sold at any time until the principal is repaid - so there are many ways of What affects the price of equities? calculating the yield. The most common is the ‘redemption yield’. This discounts the value of coupons received over time. It also adjusts for any Technically speaking, ‘equity’ is the value of a company’s assets less the value of its liabilities. The value of those assets and liabilities is dictated by difference in the price paid for the bond and the principal repaid at maturity. market forces, i.e. the stock market. Share prices are constantly changing because people in the stock market make different assessments of the company’s value. If more investors want to buy a company’s equity than sell, the price will normally increase. Similarly, if there are more sellers than However, one of the simplest is the ‘running yield’. Using the earlier example, imagine that after three years, Enterprise Inc’s five-year 5% coupon bond is buyers, the price will normally fall. worth €95 in the market, and another investor buys the bond from you. The coupon is still €5 – this never changes as it was agreed at the outset. The running yield would therefore be 5 ÷ 95 = 5.26%. Therefore, if bond prices fall, yields rise. If bond prices rise, yields fall.

More investors predict improved prospects for a More investors predict deteriorating prospects YIELD YIELD BOND BOND RISES RISES PRICE PRICE company = more buyers than sellers for a company = more sellers than buyers RISES RISES BOND BOND YIELD YIELD VALUE INCREASES VALUE DECREASES PRICE PRICE FALLS FALLS FALLS FALLS

A SIMPLE GUIDE TO A SIMPLE GUIDE TO FUND PRICING RISK PROFILING Fund pricing (continued) (BGB 10pt) Risk profiling Published May 2017 A fund pools the money of lots of investors to buy a portfolio of assets. The price of these assets fluctuates and so does the size of the fund as investors buy and sell shares. So pricing the fund is Investors have a huge choice when it comes to deciding where to place their money. They complex and needs to be fair to both ongoing investors in the fund and those wishing to deal (buy or must consider what their attitude to risk is and how they might want to diversify their sell the fund). In this guide we explain what this means in practice. investments. Risk profiled funds allow investors and advisers to match individual attitudes to risk to investment goals. How is the fund price calculated? Summary: what does the fund price include? Risk versus reward How can my attitude to risk be assessed? The fund price takes into account the value of the fund’s Underlying The fund’s assets, such as the shares, bonds assets, such as the shares, bonds and property it owns. assets or property it owns HGi.co/fundpricing HGi.co/riskprofiling Please see Before devising an investment strategy in order to reach your end A financial adviser or online tool can assist you in arriving at your Please see Several factors contribute to the fund price: investment goal, you must first establish how much risk you are willing ‘attitude to risk’ and then recommend the most appropriate investments to take. This can depend on: to match your circumstances and needs. Typically categories of · Spreads on underlying assets in the fund: When you buy an attitudes to risk can range from (1.) being risk averse to (10.) being individual share or a bond you may notice there is one price for buying · Your capacity to recover from losses should the markets fall during your highly adventurous (see example below). (the offer price) and a lower price if you want to sell (the bid price). This Spreads on The difference between the buying price (the investment period difference between the two prices is known as the spread. For widely underlying offer price) and the selling price (the bid price) Normally your attitude to risk will be assessed via a detailed questionnaire. assets in · The length of time you wish to be invested traded assets the spread may be very small and for some very liquid Don’t forget that taking on more risk can potentially lead to higher rewards the fund but also potentially higher losses. assets there may be no spread at all, such as on cash. For other assets · Which investment products you should be invested in that are not widely traded, such as smaller-company shares, the spread could be large, say 3%. It’s larger because the broker who buys or sells · Whether cash is more suitable for you the shares doesn’t want to sell you them too cheaply or pay you too for a simple guide to fund pricing for a simple guide to risk profiling Transaction · What other dependants you have relying on your investment goals much when buying them from you. The larger spread compensates the External transaction costs attached to costs buying/selling assets such as commissions, i.e. family broker for the extra risk of dealing in smaller-company shares. transfer fees and taxes Some investment products are more ‘risky’ or volatile but can offer greater · Transaction costs: There are often external transaction costs for returns over time, but the reverse is also true: you could potentially suffer buying or selling assets, such as commissions, transfer fees and greater losses. For example, shares are usually considered to be more stamp duty. These costs can vary widely depending on the type of Initial charge The cost of setting up the investment applied risky compared to bonds. For the most part, the more risk you are by the fund manager asset and where they are. For example, you need to pay 5% stamp prepared to take the greater the potential reward, but you must be aware of that before you or your adviser selects your investments. duty land tax when buying UK commercial property above £250,000.

· Initial charge: This is applied by the fund manager when you buy

into the fund. It covers the cost of setting up the investment, although INCREASING RETURNS OR PO

fund managers often offer a partial or full discount on this charge, 9. VERY HIGH RISK particularly if you invest through a cost-efficient platform.

7. HIGHEST MID RISK 10. HIGHLY The spread, transaction cost and initial charge mean there ADVENTUROUS

is essentially a buying price and a selling price for every 8. HIGH GROWTH fund, although the quoted price for the fund will depend on

the pricing method. TENTIAL RETURNS 5. LOW MID RISK 6. HIGH MID RISK

3. LOW RISK 1. RISK AVERSE

4. LOWEST MID RISK

2. VERY LOW RISK

DECREASING RISKS INCREASING RISKS A TYPICAL ATTITUDE TO RISK SPECTRUM USED BY A FINANCIAL ADVISER

For information relating to charges please see our Simple Guide to Charges

A SIMPLE GUIDE TO A SIMPLE GUIDE TO CHARGES VOLATILITY Charges (continued) (BGB 10pt) Volatility Published May 2017 Published May 2017

Investment Management can appear a complex business. When you invest in a fund, we work hard behind the scenes Investors have much to think about when choosing and understanding investments; in particular, to safely pool your money with that of other investors in the fund; we employ investment professionals to build and market volatility and the impact it can have on your investment. Extreme market volatility during the manage the portfolios, operations teams to administer the funds, and all transaction and regulatory expenses have to be met. All of this costs money, so this guide helps you to understand the charges and expenses incurred by funds. 2007-08 financial crisis demonstrated how markets can swing wildly. Understanding volatility is therefore vital to the overall process of choosing the right investments, whether you decide to make The main fund charges your own investment decision or to consult a financial adviser. If you are unsure, we recommend consulting a financial adviser if you can.

Entry charge One-off charge (we take this on the day you invest in the fund) What is it? How much? Please see HGi.co/charges What is volatility? Can you measure it? Please see HGi.co/volatility It's the maximum charge we can take from the money you use to Typically anything from zero up to 5%. invest in the fund. Volatility is how sharply and how frequently a fund or share price moves The most common measure of volatility is standard deviation. This Example up or down over a certain period of time (see example below). measures how much the value of an investment moves away or What is it for? If you put £1,000 in a fund with an entry charge of 5%, the charge deviates from its average (mean) value over a set period of time, i.e. It covers the costs of setting up your account. will be £50. This means £950 will be invested in the fund. What causes volatility? how much it rises and falls. The higher the volatility, the greater the It may also cover payments to a financial adviser, if this has been standard deviation. agreed as part of the adviser fee. Volatility can be triggered by any number of factors. The UK stock The examples below show shares with lower and higher volatility. Share market, for example, can fluctuate because of various factors both A has lower standard deviation (volatility) compared to share B which domestically and overseas; economic data from around the world, as has higher standard deviation. Ongoing charges figure (OCF) well as key political developments can trigger significant market movements. Periods of losses/downturns can be followed by upswings, What is it? How much? The duration of the investment Forecast volatility attempts to use standard deviation to forecast future for a simple guide to charges also known as rallies, and vice versa. But this is the very nature of the for a simple guide to volatility The OCF is a single figure that represents the charges you'll pay An OCF can typically range from 0.25% to 2.5% each year. variation in returns. The higher a forecast volatility figure, the more an stock market. over a year for the length of time you hold your investment. It is investment could move both up and down over time. usually stated as a percentage of the fund value. Example A fund with a constant value of £1,000 over a year and an OCF What is it for? of 1.5% would have a charge of £15 in that year. Put another The OCF covers aspects of operating the fund each year. It way, if the same fund achieved a return of 10% a year, the OCF £1 Share A £1 Share B includes fees paid for managing the fund such as the annual would reduce the return to 8.5%. A breakdown of a typical Janus Lower volatility Higher volatility management charge and our administration and oversight tasks. Henderson OCF is shown overleaf. See overleaf for more details.

Conditional charges Portfolio transaction costs Price Some funds have conditional charges that are triggered when they All funds also incur various transaction costs. Price meet specific predefined targets. The most common conditional For example, when a fund buys or sells shares, charge is a performance fee – a fee that generally aims to this incurs broker commissions, transfer taxes reward good fund performance. So if the fund achieves a certain and stamp duty, which the fund pays on each level of return, we can take part of that return as a fee for good transaction. Transaction costs for some Janus performance. For further information please refer to our guide to Henderson funds are shown at HGi.co/by5r absolute return funds at HGi.co/d33 0 0 Time 5 years Time 5 years

Exit charge One-off charge (day fund is sold) Source: Janus Henderson, for illustrative purposes only

What is it? How much? We may take an exit charge when you sell part or all of your If a fund applies a charge, the amount is often discretionary. holding in the fund although this is extremely rare. Example What is it for? A fund that applies a 5% exit charge when it is sold at a value of It typically covers the costs if you sell your investment early. £2,000 will make a charge of £100. This means the investor will receive £1,900. Some funds may make a charge to deter excessive short term trading.

Contact us General enquiries: 0800 832 832 Email: [email protected] Website: janushenderson.com

Janus Henderson Investors is the name under which Janus Capital International Limited (reg no. 3594615), Henderson Global Investors Limited (reg. no. 906355), Henderson Investment Funds Limited (reg. no. 2678531), AlphaGen Capital Limited (reg. no. 962757), Henderson Equity Partners Limited (reg. no.2606646), (each incorporated and registered in England and Wales with registered office at 201 Bishopsgate, London EC2M 3AE) are authorised and regulated by the Financial Conduct Authority to provide investment products and services. © 2017, Janus Henderson Investors. The name Janus Henderson Investors includes HGI Group Limited, Henderson Global Investors (Brand Management) Sarl and Janus International Holding LLC. H032141/1117