Timing is everything

However, certain industry research suggests that in the past year not one absolute return vehicle managed to meet its performance target with the vast majority failing to even match cash.

Pointing out that absolute return funds set their own targets, typically with the aim of generating a certain percentage over cash, this underperformance has been put down to difficulties in the area of fixed income investments.

However, Fiona Laver, investment director of UK equities at Scottish Widows Investment Partnership (SWIP), says that absolute return funds must be viewed as long-term investments that ultimately deliver a cash-plus return for a relatively low level of risk. Taking a short-term view on performance and focusing on returns to the exclusion of risk, she said, will not give an accurate picture of a fund’s health.

“In today's market, where we are seeing increasing volatility, absolute return funds have a key role to play. Absolute return vehicles aim to deliver a positive return, over the long term, regardless of market conditions.”

For Richard Buxton, manager of the Schroder UK Alpha Plus fund, the most important part of running a fund on an absolute return basis is viewing risk in the same way as the man on the street – the risk of losing money in absolute terms.

“Many fund managers follow the industry line and define risk based on deviation from an index,” he says. “The trouble is, that doesn't offer much consolation if your low-risk, low-deviation portfolio falls 10% as the market does.”

Buxton prefers to take an index-unaware, absolute-return approach, only investing in what he believes are the best opportunities in the market. This is because he believes in the long term the result will be lower risk in the sense of actually losing money.

“If we don't like a company, we don't have to invest in it, even if it is a large part of the index. A good example of this has been Vodafone. By not owning the then ailing mega-cap stock during 2005 and 2006 and favouring O2 instead, we were able to add 2% to performance in relative terms.”

Of course, true absolute return vehicles blend a number of uncorrelated asset classes with the aim of generating a positive return in any prevailing market condition.

As Craig Inches, manager of the Swip Absolute Return Bond fund, says: “The absolute return strategy gives us greater scope to use sophisticated tools and techniques, such as derivative overlay strategies, to add significant value in any market environment and to help us achieve steady absolute positive returns over the longer term.”

As with any other type of fund, viewing performance over short one-year timeframes fails to give an accurate picture of the performance of absolute return vehicles. However, these products require to be judged over longer periods because, by design, their rises should be gradual, regardless of market fluctuations.

1 August 2007