Do absolute return funds have a future?

"In the first quarter of 2020, when volatility was very high, one of the best known funds in the sector lost 20 per cent. The thing is, that fund was very net long in terms of its equity exposure, and I would ask, if you are that significantly exposed to equity market risk, how can it be an absolute return strategy, which aims to deliver a return in all market conditions, be in a position where a drop in equity markets means the fund loses money?"

He says this is the fundamental contradiction at the heart of traditional absolute return strategies: if they do not have significant equity exposure, then it is hard to achieve attractive returns, even if the volatility is high, while if you have little exposure to equities, you get low volatility but low returns. 

 Historically many absolute returns funds haven’t taken a great deal of risk in the belief that they were protecting investors' capitalBoyle, Atlantic House

Hovenden’s solution is to recommend for clients only those funds within the sector that also engage in the short-selling of equities, as this enables one to profit directly from the fall in equity markets as well potentially the rise, allowing for equity exposure that can also have lower volatility.  

Argonaut's Norris does engage in short-selling in his fund. He says: “Short-sellers get a bad rap. This is partly because the things we short sell are in areas where there is a dominant narrative. One example of this right now might be renewable energy. We think there could be profits to be made from short-selling renewable energy companies for the next decade. But it is not something people want to hear, and we are aware it doesn’t always work.”  

He adds he would always have a “net long” position in the portfolios, meaning he will always have more equity investments that are profitable if they rise in value than if they fall in value. 

Fitzgerald also engages in short-selling in his funds, but says the major change in markets now is likely to be that the characteristics of a company, such as whether it is profitable or not, have become more important than the geographical location or the sectors in which it operates.

David Thorpe is special projects editor at FTAdviser