Absolute return investing has seen a surge in interest from retail investors throughout 2016.
When one considers the market environment investors have found themselves in, however, the increased demand for absolute return funds does not come as much of a surprise. We have been in a risk-off environment for some time, global equity valuations are stretched, bond yields are low – with some government bonds now in negative return territory – and we are seeing increased market volatility.
As economic growth remains uncertain in many economies, and interest rates remain at record lows, a number of retail clients are seeking downside protection. Events throughout the year, such as the UK voting to leave the European Union, have served to exacerbate this further.
Against this backdrop, the search by investors for alternative return solutions, which can provide an added benefit of lower volatility, is more prevalent than ever before. The risk-off environment has fuelled investor appetite for such solutions and in fact the Targeted Absolute Return sector has been the best-selling UK retail sector for six of the first eight months of 2016, according to statistics from the Investment Association.
In short, absolute return investing simply means offering the potential for positive returns regardless of the market environment. This makes them different to many other funds, which in some periods can still outperform a benchmark, but produce negative returns. Absolute return funds also aim to provide returns with a lower rate of volatility than traditional markets. These funds can act as a complement to traditional asset classes such as equities, fixed income and cash, as they can achieve uncorrelated returns. They are therefore an important source of diversification for a balanced portfolio.
There is still a common misperception that many absolute return funds are the same as hedge funds, being high risk and using derivatives and leverage to produce returns. While some do use sophisticated instruments, absolute return solutions come in many different shapes and sizes and with varying strategies, risk profiles and objectives. Some are long-only bottom-up funds, while others might use a combination of long and short positions and some may take a systematic approach.
Having an increased number of funds to choose from is positive, giving more opportunities to better match a fund to a client’s specific risk profile and needs; however, there are considerations that need to be taken into account. Importantly, the difference between funds within the sector means that looking at the sector-wide performance of these products can be misleading; it is impossible to make general assumptions about the performance or attractiveness of the sector as a whole.
It is also important to understand that positive returns are never guaranteed. Advisers must get under the bonnet of these funds to find out about their specific profile, time horizon and aim, to ensure they are considered in line with a client’s needs.