5 things you should know about absolute return funds

6th August 2010

The disparity of returns is increasingly wide, despite a worrying expectation among investors that ‘absolute' should mean ‘guaranteed'. How can investors ensure that they select the right absolute return fund for their individual objectives?

Performance measurement in the sector is tricky only 13 of the 44 funds in the sector have a three year track record. However, performance has varied between +8.5% to -17.9% for the year to date (source: Trustnet to 5 August). Over three years, the difference is from +44.9% to -13.6%. This is considerably wider than might be expected and shows the importance of careful selection.

Richard Pursglove, head of retail at Gartmore, says: "From a consumer's perspective one has to think about not necessarily what returns have been achieved but how they have been achieved and that does require a little bit of analysis in terms of the risks that have been taken."

What factors should investors assess when choosing an absolute return fund?  

1)      Asset class There are three main approaches in the absolute return sector: equity long/short; fixed income and multi-asset. Each approach will perform differently in different market environments. For example, equity strategies have struggled since the start of the year because of huge volatility in markets; fixed income strategies have done better because fixed income markets have been more benign.

2)      Volatility target

Some funds will aim to grind out returns with low volatility in all market conditions (market neutral funds). Others will aim for a higher overall return by taking on more risk. For example, they will aim to predict the direction of a market and adjust the portfolio accordingly (market directional funds). This will inevitably create additional volatility. This should also be clear from the benchmark – those funds aiming for, say, Libor +4% will need to take on more risk than those aiming for Libor + 2%.

3)      Correlation

For the majority of investors, the role of absolute return funds within a portfolio will be to improve diversification. They will only do this if they show little or no correlation to the other assets in a portfolio – eg. Property, equities, bonds. All absolute return funds should be able to provide their correlation with standard equity indices such as the All-Share.

4)      Experience

The strategies employed in an absolute return strategy are more complex than those in a standard equity portfolio and experience counts. Although few have long-term track records, as Pursglove points out: "It is an embryonic part of the industry, but it is not an embryonic strategy". Most fund managers have a track record of running offshore funds and potential investors should see whether this stacks up.

5)      Geographic bias

The sector now contains funds focused on Japan, Europe and there are plans to introduce US-focused funds into the sector. These will affect the overall geographic skew of a portfolio and this should be taken into account.

Further reading:

http://www.fundstrategy.co.uk/features/cover-stories/which-road-to-absolute-returns?/1014560.article

http://www.thisismoney.co.uk/investing/tips-and-guides/article.html?in_article_id=489206&in_page_id=53934&in_advicepage_id=105

This fantastic graph gives risk-adjusted return for different absolute return funds. As far left and as high as possible is good:

http://citywire.co.uk/money/fund-and-fund-manager-performance/-/unit-trusts/absolute-return/returns-vs-risk.aspx?CitywireClassID=2166

 

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