Absolute return funds have become commonplace in recent years, but the term creates some confusion, ...
Absolute return funds have become commonplace in recent years, but the term creates some confusion, according to Robert Neilson, senior product specialist at Pioneer Investments.
The severity of the 2000-2003 bear market left scars, removing the focus from benchmark-focused approaches and leading to the subsequent emergence of absolute return vehicles. But this is a very broad term and many flavours of funds are categorised as absolute return portfolios, including Libor plus, equities, flexible fixed income, currency funds, hedge funds, multi-asset and asset allocation funds.
Neilson said not all these are true absolute return funds. He defined these as mandates that seek to achieve positive returns over a defined time horizon, while minimising the probability and size of losses.
He said: "Typically, these target returns above cash and offer a more stable return profile versus long-only funds. There are a myriad of different investment approaches and styles in achieving this."
Neilson said absolute return funds are not guaranteed return funds, hedge funds or a do it all replacement for traditional long-only portfolios. They are not benchmarked in the same way as long only portfolios.
Within an absolute return fund, core holdings such as low risk fixed income securities can provide the risk-free rate or match Libor. But then alpha strategies are required to deliver the excess return layer.
Finding uncorrelated alpha strategies is key. It is core to have equity exposure, active currency positions, yield curve management, active duration positions and spread and carry trades, he added.
Neilson said this is where derivatives have a beneficial role to play. These enable portfolio risks to be managed more accurately and proprietary research ideas to be fully exploited in portfolios. He added derivatives can also be used to reduce risk. For example they are used to lock in a certain minimum return.
The new Ucits III framework for mutual funds in the EU means that open-ended funds, which contain such instruments and target absolute returns, have become possible.
Despite the benefits offered by absolute return funds, Neilson said many challenges lay ahead in this area.
He said: "These are a relatively new concept for investors and absolute return funds have short track records. The role of absolute return funds must also be defined and investor expectations set at a realistic level." key points
Bear market has led to emergence of total return funds
These come in many breeds
Typically they target a return above cash
To promote 'long-term investment'
Switching 'hard and expensive'
Smaller funds still packing a punch
To drive progress