Absolute Return  

How to navigate absolute return funds

  • Learn what an absolute return fund is and why the sector has been criticised by the regulator.
  • Understand how to measure risk and performance of absolute return.
  • Comprehend how the fees are charged.

These different absolute return fund investment strategies can be confusing.

1.    Long-short equity or equity market neutral strategies

Most investors are comfortable with the notion of owning company shares via a fund that attempts to beat its benchmark. However, a long-short equity fund ‘goes long’ and buys company shares that it believes are undervalued, and borrows (and sells) to ‘go short’ shares in companies that the fund managers view as overvalued. 

The benefits to this are firstly to take advantage of more mispricing opportunities on the short side within equity markets, and also to reduce net exposure to the equity market. In the latter case, if equity short exposures roughly cancel the fund’s long holdings, then the fund’s directional exposure to the underlying equity index is similarly reduced and the fund is then positioned as ‘equity market neutral’.

2.    Long-short bonds

Quite simply the same strategy as long/short equity, but involving bonds and fixed income securities only.

3.    Multi-asset

Generally, these funds invest in a diverse range of assets, but are long only. This will include fixed income, equity, property, commodities, infrastructure and others. Generally multi-asset funds will not use a large number of derivatives, except for efficient portfolio management. 

4.    Macro funds

Very similar to multi-asset funds, but with more focus on global macroeconomic themes and events. Macro funds tend to be very top-down and are likely to employ more futures and derivatives than a multi-asset fund, for example, to make long and short foreign exchange positions or short a commodity.

5.    Multi-strategy funds

Potentially the most complicated of all the absolute return fund types, these funds aim to involve any strategy that is capable of generating a return. Multi-strategy funds can include any of the investment strategies mentioned above.

In theory, multi-strategy funds are more diverse than single strategy funds, and frequently employ specialist quantitative risk analysts to understand all the positions within the fund, how they are diversified and their potential performance during stress test periods – both historically occurring and hypothetical. 

In all the absolute return fund types described, an adviser should do their due diligence to understand the structure of the investment team and the range of expertise informing positions into the fund. The number of personnel and level of experience within the risk team can be very illustrative of how well ‘targeted’ the fund’s absolute returns will be.

Absolute return funds may appear complicated, however, an adviser should consider against other decumulation investments. 

For example, direct property holdings are often mentioned as providing steady income generation and are also purportedly suitable for retirement. It is questionable whether investors properly appreciate the illiquidity risks when investing in property, as seen with the various redemption holds that were put in place following the Brexit vote in 2016.