Going one better

The volatile market conditions that we have experienced over the past year or so have caused many people to do a reality check on the sort of returns that they can expect from their investments. Equities have fallen in value and asset classes have tumbled across the board, bringing an end to the bull market that started in 2003. One strategy that has been particularly attractive of late is absolute return investing.

With an emphasis on always recording a positive result, absolute return funds invest in an array of asset classes with the aim of bucking market trends. However, the exceptional market conditions that were experienced during the past couple of months have taken their toll on absolute return strategies, with many of them now sitting in negative territory. This shows that absolute return funds have as much capital at risk as conventional equity investments, despite being designed to preserve capital.

While they may fit well in the equity allocation of a portfolio, an absolute return fund may not be appropriate for parts of the portfolio where investors do not want to risk their capital at all. So how can investors access these strategies when they do not want their capital put at risk? One option may be to combine an absolute return strategy with the same type of capital protection used in protected funds and structured products.

Dawn of absolute return funds

While the wider concept of absolute return investing is not new and has been utilised by institutions and high net worth individuals for a long time, it is only in recent years that retail investors have had both the desire for, and access to, products that have adopted this approach. Absolute return funds certainly make sense for many retail investors as it could be argued that what matters in an investment is that it has recorded a positive return, rather than simply beat a benchmark that might have produced a negative result for the year.

Such has been the popularity of absolute return funds that the Investment Management Association (IMA) set up the Absolute Return sector in April, incorporating both UK and overseas domiciled funds with distributor status. At present there are 17 funds in the sector, of which the following five have a track record of more than three years:

• BlackRock UK Absolute Alpha• Henderson Emerging Market Debt Absolute Return• Marlborough ETF Absolute Return• Newton Absolute Intrepid SIS• Threadneedle Absolute Return Bond.

While there is no asset based monitoring for the IMA Absolute Return sector and inclusion is at this stage voluntary, as part of its definition the IMA states that "typically funds in this sector would normally expect to deliver absolute (more than zero) returns in each year."

The term absolute return can mean different things to different people, but broadly the objective is straightforward: It is about delivering positive, incremental returns, irrespective of conditions in financial markets and irrespective of any benchmark, typically with the objective of achieving reduced volatility. There are a number of tools available to fund managers in order to achieve this, with the UCITS III and NURS directives allowing increased flexibility in terms of how managers can attempt to deliver absolute returns. The response to these regulations has been a proliferation of long/short and 130/30 funds, both of which in effect replicate hedge fund strategies and make them available to retail investors.