How to navigate absolute return funds

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. 

Arguably, at least with an absolute return fund you are much more likely to have more diversification. Many retail investors often do not grasp this point.

How to assess risk

For most advisers looking to avoid sequencing risk for their clients, the first measure to focus on is the absolute return time period. Typically, funds in this sector target being positive between over any one-year to three-year period. 

The shorter the time period, the less risk the fund is likely to take and the lower the drawdowns the fund could achieve. 

Some absolute return funds also target any five-year period, but it is questionable how useful this is for an investor who is post-retirement and attempting to avoid the effects of sequencing risk. A fund with this time horizon has more chance of experiencing a longer period of losses, thereby increasing the potential effects of sequencing risk.

The main difficulty investors face when assessing absolute return fund performance is that many funds have only launched recently.Jason Baran

Another way to measure the risk of absolute return funds is to consider how they have performed in volatile market periods. 

While not many absolute return funds were around during the 2008 global credit crunch, there have been smaller market events since then such as 2011’s ‘taper tantrum’ (when the US Federal Reserve indicated it may start raising interest rates), or the UK’s Brexit referendum vote in the middle of 2016. 

During these short-term volatile market episodes, a decent absolute return fund should limit losses and remain stable.

Remember, well managed absolute return funds seek to generate stable returns during all market environments in order to reduce sequencing risk. Funds making simplistic directional bets are likely taking too much risk and the volatility of the returns can be just as important as their size. 

Performance pitfalls