What exactly is an absolute return fund?

With such a wide variety of options to choose from, exactly what does it mean to be an absolute return fund?

Iain McLeod, multi-asset investment specialist at Standard Life Investments (SLI), says: “It means that the fund manager is adopting strategies, I think, to always try and generate a positive return irrespective of the prevailing market conditions. So you’re not just comparing yourself to outperforming say the UK equity index, and if the index goes down by 20 per cent and you go down by 18 per cent that’s a success. It is not a success for an absolute return fund. You’ve got to try and deliver consistent positive returns for clients.”

Juan Valenzuela, investment manager at Alliance Trust Investments, agrees that an absolute return strategy provides managers with the necessary investment framework to theoretically generate positive returns in all market conditions.

He adds: “Such funds generally rely on derivatives related to their investment strategy that are used to minimise downside risk and allow for positive returns when markets are trending lower.”

However, Ian Heslop, portfolio manager of the £73.6m Old Mutual Global Equity Absolute Return fund, says that from his point of view, absolute return is a separate asset class.

“The underlying fundamental thing you should be achieving with these types of funds, I think, is complete non-correlation with other asset classes. What that means to me is when you’re building the portfolio, the portfolio returns shouldn’t be affected by the market type that you are in, in as much as there is not really much point in having an absolute return fund that only outperforms when the market is going up for instance.

“For me, an absolute return fund should be all the things most people think about, which is very well-managed liquidity profiles and very well-managed volatility profiles, volatility being a very important part of what you’re getting with an absolute return fund, but also these uncorrelated returns.”

Mr McLeod notes that while SLI employs a global macro, multi-strategy approach with its Global Absolute Return Strategies (Gars) vehicle, it is just one of many options for investors.

“There are a number of other funds out there, some are purely long/short equity funds, there are debt arbitrage funds, currency funds, all sorts of different ways you could do it [achieve an absolute return].

“But from a client’s perspective, the strategies being adopted, although important, are maybe a little less so than the manager having an articulation of what they are doing and what the objectives are in terms of outcome for the client.”

Mr Heslop adds: “I think the space itself is quite heterogeneous, it is very different. Even from the perspective of equities you could be equity long/short or pure market neutral. Even within the equity space there are investors doing different things and it is beholden upon investors to understand that. Even looking elsewhere you’ve got investment funds that do arbitrage, whether it is value, volatility or takeover, there are different asset classes, credit funds and that sort of investment process. It is a very mixed bag, it is important to understand what people do, but actually there is an argument of trying to understand what the outcome is expected to be alongside their investment process, and that’s really what you’re basing the decision on.”

He further questions: “What is their volatility? What is their correlation to other assets I hold within the portfolio? What will it do to the portfolio if I include this fund? I think people are considering absolute return funds at the moment because it’s a way of getting diversification that is harder to get in the underlying asset classes now.”

Mr Valenzuela notes that to properly compare funds, the first thing an investor should do is be aware of the underlying asset classes the fund is getting exposed to, as in the absolute return fund sector there are both multi-asset classes and single asset classes.

“Irrespective of the fund that an investor is getting exposed to, there should be a good understanding of the risk parameters utilised by a manager, the sources of performance and the investment style of each manager. This will underpin the sustainability of past performance and volatility and should minimise disappointments”, he says.

Nyree Stewart is deputy features editor at Investment Adviser

Adviser view

Martin Bamford, chartered financial planner and managing director of Informed Choice, says:

“Morningstar believe there are as many as 18 different strategies currently employed by targeted absolute return funds in the UK. These strategies typically involve short selling, gearing returns and very high turnover of holdings in the portfolio.

“All it really means to be in an absolute return fund is that the manager is aiming to deliver an absolute return, regardless of market conditions.

“This is a noble aim, but rarely achieved with any consistency. Investors are usually better advised to hold a well diversified portfolio of more traditional funds, rather than expose their wealth to these pseudo-hedge fund style absolute return funds which often come with high charges, inconsistent performance and opaque strategies.”