Abandoning absolute return funds now could be an unwise move

IN recent years, the fund sub-sector seeing the greatest inflows has been the multi-asset absolute return sector. Somewhat ironically, it has also been the sector facing some of the most intense criticism.

Absolute return funds share many similarities to hedge funds. Like hedge funds, they aim to deliver positive returns in all market conditions and have the freedom to pursue any variety of investment strategies — complex or otherwise — in pursuit of that goal. They differ to hedge funds in that they are more regulated, more transparent, more affordable and, thus, more suitable to the average retail investor.

When done well, the hedge and absolute return style of investing is in tune with the way most people want to invest — consistent and predictable returns, compounded over time, where the capital value is not subject to large swings.

The trouble is that across the absolute return landscape, only a small proportion of managers can claim to have consistently delivered on these expectations over extended periods of time. Furthermore, the investing community has not been shy in voicing its discontent. The regular detractors bemoan lacklustre returns and higher than expected draw-downs, while the most vocal critics go as far as to question the very concept of absolute return investing itself, and whether the idea of consistent positive returns with low volatility is even plausible. They contend that investors are being sold a “have your cake and eat it too” pipe dream that frankly can’t be achieved.

The criticism is not without merit. However, while investors should be made aware that an investment in hedge or absolute return funds does not automatically grant that capital immunity from decline, there is a strong case to be made that now would be an unwise time to abandon the space altogether. The current market rally has persisted for more than eight years, making it the second-longest period without a 20pc market decline since the Great Depression. The duration of this market rally — combined with historically elevated asset valuations and record levels of margin debt — strongly suggests that now is a good time to seek out strategies designed to protect capital in difficult markets. Active managers’ ability to dynamically deploy capital at different points of an economic cycle have enabled them to perform this role in the past, suggesting absolute return strategies may have an important role to play in the near future.

The most important factor for investors is choosing the correct fund manager for them.

Given the diversity of the sector, where funds with similar-sounding titles pursue very different objectives, that is easier said than done. Investors with a preference for capital preservation might consider funds with strong track records through recent bouts of market turbulence (such as the taper tantrum of 2013). Lesser-known investment houses should not be discounted either, if you can find managers there with specialties and who will actively own the investments they are endorsing for clients in a personal capacity. Investors must look under the bonnet of hedge and absolute return funds and understand how that fund can — or can’t — be expected to fulfil its investment portfolio role.

If that sounds too cumbersome, a traditional multi-asset fund (made up of cash, government bonds and equities) can do a fine job for less effort and (probably) a better night’s sleep.