Having the ability to keep your promises

Absolute return funds are supposed to supply returns whichever way the market moves. Designed to be able to short out-of-favour stocks as well as buy those on the way up, the extra flexibility should allow managers to post positive results whether the stock market is up or down.

At least that is the theory. In practice, however, the picture is a little cloudier, with many absolute return funds struggling to push past Libor plus 1 over 2007, and some even posting negative results.

One of the more successful funds, BlackRock's £630m UK Absolute Alpha, managed by Mark Lyttleton, is up by 10.68 per cent since the turbulence hit at the beginning of July last year. This compares with a fall by the FTSE100 of 11.64 per cent, and 11.92 per cent by the FTSE350.

The point is simple: even when the main markets went down, investors in Mr Lyttleton's fund still made money.

But not all managers are as skilled as he is. IFAs have started to question whether absolute return funds actually are delivering on their claims. "In the current climate, we will start to talk about absolute returns a lot less," points out Mark Loydall, director of Loughborough-based IFA Cambourne Financial Planning. "People are still hoping to achieve positive absolute returns, but whether they do or not is another matter."

For example, while it still posted positive returns, ABN Amro's ARBF V300 fund was up by just 2.93 per cent over the period from 1 July.

"We hold our hands up and admit we have not delivered over the last six months," admits Dan James, nominated chief investment officer for absolute returns at Fortis Investments. "But to be that microscopic in terms of timescale is not a fair way to view the asset class. You have got to look at how it sits in your overall portfolio and see what you are using it for."

Mr James's point about diversification is a fair one: in times of market turbulence it is best to spread your funds over many different asset classes. But the key point is whether or not absolute returns funds are living up to their claims.

"Absolute returns is the holy grail of investing," explains Kate Hollis, director of fund research and lead analyst on absolute returns funds at Standard & Poor's. "It is what every investor wants - to make money in any condition."

With the advent of Ucits III, funds now have the ability to short market risk, she continues, "and in a market that is going down rapidly, if you can be short the market you have the chance to make a decent amount of money".

Fixed income v equity funds

Ms Hollis sees a clear separation within the category between those fixed income strategies and equity funds.

"Fixed income managers have used derivatives longer and more often than equity managers," she says. "And under Ucits III you can only use derivatives to be net short, which means the greatest number of absolute returns funds come out of the fixed income process."