By using sophisticated investment techniques such as shorting (profiting when prices fall) they aim to make modest yet consistent gains with smoother performance than traditional funds. These are admirable objectives that resonate with many investors. However, for me, the jury is still out on whether they make good investments.
Many absolute return funds that launched four or five years back have simply failed to deliver. Some have even closed following embarrassingly poor returns. A number relying on a fund manager’s stock selections (typically pairing long positions with shorts) have been particularly disappointing.
The message here is that no matter how good a fund manager’s process is, it won’t work all the time – so year-in, year-out positive returns from a single absolute fund are not necessarily a realistic objective.
It is also striking that the relative performance of absolute return funds has withered as interest rates were cut to historic lows.
This is because they typically hold quite large amounts of cash while offsetting long and short positions through derivatives to create a broadly market-neutral portfolio. Stripped of the ability to earn interest on cash, and with the headwind of fees, funds have had to work harder to get the same results.
Like any fund, I believe they should be treated as "buy and hold" investments.
They often experience long and dull periods, which make them difficult for less patient investors to keep – especially if markets are roaring ahead.
Therefore they will not suit all tastes. However, they can still serve an important role in terms of diversification and helping control the volatility of a portfolio when used sensibly to help form a lower-risk core.
Personally, I believe there is little point in using a single absolute return fund, particularly if it concentrates on one strategy. If you are serious about using absolute return as part of your portfolio, then blending a number of different strategies seems sensible.
Funds vary greatly in terms of level of risk and each one needs to be considered on its own merits rather than making direct comparisons with others or the peer group as a whole.
There are three absolute return funds we prefer across the major sectors.
Standard Life Global Absolute Return Strategies has been successful precisely because it uses a wide number of investment methods. It also doesn’t have a performance fee, which most others do.
Performance of fund vs indices over 3yrs
Source: FE Analytics
However, using a range of absolute return funds can help spread the risk of a chosen manager underperforming.
The other two funds we like are MST Melchior European Absolute Return and Liontrust European Absolute Return; both single-strategy funds that have been through a tough time recently.
Perhaps unsurprisingly, given recent buoyant markets, few fund groups seem to be promoting absolute return funds at the moment.
They were an easy sell when markets were falling out of bed during the credit crisis in 2008, but I always think the time to be looking at capital preservation strategies is when markets are doing well, so now could be an opportune time to take a fresh look at the sector.
Ben Yearlsey (pictured top of first page) is head of research at Charles Stanley Direct. The views expressed here are his own.
Click here to learn more about absolute return investment strategies, with the FE Trustnet guide to absolute return.
