These aim to provide positive returns in rising and falling markets by using a series of complicated strategies.
Among the tools at their disposal are short positions, which make them money when a particular security goes down, and long positions.
Although such strategies have come under fire as being "immoral", they represent one of the few methods that allow investors to make positive returns in falling markets.
Here we take a look at some of the more retail-friendly funds that have proved successful in running long-short strategies in the volatile markets of the last few years.
Standard Life GARS
The £13bn Standard Life GARS fund is one of the most popular in the IMA universe, having seen net inflows of £3.1bn in 2012 alone, according to data from FE Analytics.
The fund has made money in every calendar year since launch, including 2011 when the average fund in the IMA Absolute Return sector lost 1.26 per cent and the FTSE All Share was down 3.46 per cent.
Year-on-year performance of fund
| Name | 2013 returns (%) |
2012 returns (%) | 2010 returns (%) | 2009 returns (%) |
|---|---|---|---|---|
| Stan Life Inv - GARS | 0.79 | 6.91 | 9.82 | 18.47 |
Source: FE Analytics
FE Research's Charles Younes said: "The recent markets haven’t been good for hedge funds, you aren’t getting the 10 per cent per annum that you used to be able to get, but there are some funds that are able to return 5 or 6 per cent fairly reliably."
In November of last year, the analyst explained the fund’s strategy for our readers.
One of the key pillars is a market-relative approach, which means that the fund balances any bullish stance with short positions to hedge the risk.
This kind of strategy could be particularly appealing in a situation such as the present, when opinion is divided about whether the uptick in the markets will endure.
The fund requires a minimum initial investment of £500 and has a total expense ratio (TER) of 1.59 per cent.
SWIP Flexible Strategy
Unlike GARS, SWIP Flexible Strategy sits in the IMA Specialist sector; the fund is also dwarfed in terms of size, amounting to just £37.2m.
The fund had a poor 2008, but manager James Clunie took over in August 2009 and has produced positive returns in each calendar year since then.
It is up 23 per cent over three years, with an annualised volatility of just 6.28 per cent. For comparison, the volatility figure for the FTSE All Share is 13.54 per cent.
Younes explains that the manager runs a simple long-short strategy on a valuation basis, looking on a stock-specific level to see what companies are over- or under-priced by the market. The fund holds roughly 40 long positions and 10 to 20 shorts.
Younes said: "When I met the manager, what really impressed me was his honesty about his mistakes. He basically said: 'This is what I did wrong, this is what I learned and this is what I am going to do differently.'"
"Most of the time when you meet a manager he talks about his process and his results, but this really impressed me."
Clunie told Younes that he went short on insurer Admiral too early, and had to sell out of his position to cut his losses, only to see the stock fall as he had expected.
A short position on tech firm Croda was another of Clunie’s mistakes, with the manager explaining he learned to wait for a catalyst before making his play.
The fund is available with a minimum initial investment of £1,000 and has a TER of 1.69 per cent.
Insight Absolute Insight
This five crown-rated fund is effectively a fund of funds that largely holds other Insight portfolios, but has the freedom to invest in products from other providers.
The £465.3m fund is managed by FE Alpha Manager Reza Vishkai and Sonja Uys and has made 27.91 per cent over five years.
Its longer track record means that investors can track its performance through the down-market of 2008, which is not the case with GARS.
The fund was essentially flat over that year, losing 0.16 per cent, and has made positive returns in every year since.
The portfolio has ongoing charges of 1.49 per cent, but this does not include the performance fee.
This amounts to 10 per cent of the returns above the 3 month GBP Libor benchmark. FE Analytics performance data takes into account these charges, however.
Investment trusts
For more adventurous investors, there are some "investment trusts of hedge funds" that have produced impressive returns.
Two funds stand out for their five-year track record: Brevan Howard Macro and BlueCrest Allblue.
The Brevan Howard fund has marginally outperformed the BlueCrest portfolio over five years, and both have massively improved on the lacklustre performance of the sector, which has lost 14.04 per cent over this time.
Performance of trusts vs sector over 5yrs
Source: FE Analytics
BlueCrest Allblue is essentially a fettered trust of hedge funds, in that it only invests in portfolios run by BlueCrest. Its largest holding is the BlueCrest Capital International fund.
The trusts in the IT Hedge Fund sector have tended to dramatically underperform in falling markets, in particular in 2008.
The average trust in the sector lost 37.06 per cent that year while the average absolute return fund was down just 3.6 per cent.
Many trusts went on to a discount that year, compounding their NAV losses, while the illiquid nature of the assets invested in by some will have added to the difficulties.
Both Brevan Howard Macro and BlueCrest Allblue outperformed their sector in that year, losing just 7.29 per cent and 8.37 per cent respectively.
Brevan Howard managed to make 24.6 per cent in 2011, the next year of falling markets, in which the sector lost 1.15 per cent.
Both funds are members of the AIC, and while the BH Macro fund is currently on a discount of 2.6 per cent, the BlueCrest Allblue fund is trading on a discount of 5.6 per cent.
While the ongoing charges on the BH Macro fund amount to 4.93 per cent, including the performance fee, the BlueCrest Allblue fund is exceptionally cheap.
According to AIC figures, the ongoing charges are just 0.07 per cent, thanks to the unusual structure and compensation policy of the trust in which there is no separate investment management team and flat fees are charged.
The administrator takes an annual fee of £56,000 plus £500 for each £5m tranche of NAV in excess of £30m, according to the AIC.