Focusing on what absolute return can offer investors and key considerations for advisers when recommending this type of investment
What is absolute return?
Absolute return can cover a whole myriad of different structures, risk characteristics and return expectations so advisers first need to ask what absolute return means in the context of any product or fund group. For the sector, that means aiming to deliver a positive return over one year, regardless of market conditions.
Advisers also need to start thinking about absolute return funds and the long-only space as two completely separate asset classes. Long-only funds clearly aim for a return that is relative to a particular benchmark whereas an absolute return fund, while often compared against the market, should more realistically be compared against cash or a risk-free rate of some sort.
What can absolute return funds offer?
Absolute return investing is all about diversification. Advisers are trying to build balanced portfolios, which nowadays often comes down to multi-asset, and achieving a proper diversification across different asset classes. Absolute return offers a different series of characteristics – it should not be correlated to equities and should have a low beta relationship to the market as well.
So, with absolute return, you are looking to access the skill of an individual fund manager to get what might be described as a ‘shock absorber’. It will not keep up fully when markets go up but it will aim to provide you with positive returns when markets fall. Anything between perhaps 5% and 20% of a portfolio could be allocated to absolute return funds, depending on a client’s risk appetite and profile.
What should advisers consider when deciding to recommend an absolute return fund?
The big mistake would be to think these funds cannot go down because they can. Investment groups and advisers need to be doing a lot to manage client return expectations as well as getting them to understand the returns should be judged against cash. There was a time when investors were used to making 15% a year, which was unsustainable, but, equally, cash now yields 1% with inflation around 3% so clearly cash deposits are not the long-term answer for consumers.
Furthermore, it is not just about managers and strategies, it is also about a fund house’s risk overlay and systems. Running absolute return strategies is not just a case of sitting down at a desk and building a portfolio – the work from an operational and risk overlay perspective has to fit in behind to ensure a robust process. The more of these strategies that come to the market, the greater the confidence should be in their ability to deliver.