Absolute Return Strategy
Absolute return investing aims to produce a positive return over time, regardless of the prevailing market conditions. Even when markets are falling, an absolute return fund still has the potential to make money. Producing consistent positive returns is the key objective for an absolute return fund.
All investment funds aim to beat the long-term returns from cash. However, unlike a traditional long-only equity fund where investors accept the risk that equity markets can fall dramatically from time to time, an absolute return – by not being tied to any particular equity benchmark – aims to produce more consistent positive returns over a given investment horizon. Investment gains can never be guaranteed but, by using a range of techniques not available to traditional investment portfolios, absolute return funds have the capability to generate smoother returns throughout the market cycle. Although they vary widely, absolute return strategies usually have most of the following characteristics1 :
- Generally, they utilise sophisticated investment manager skills and systems to generate active returns.
- The strategies are typically less constrained, allowing managers to take opportunities in a wide range of market environments (e.g. use of short-selling, derivatives etc).
- The strategies tend to be more complex than those that are typical in traditional 60/40 portfolios.
- Manager remuneration is more aligned with fund performance.
- Liquidity is sometimes conceded in return for the likelihood of higher risk-adjusted returns as these investments seek different risk premia not readily available to retail investors.
WHAT ARE SOME EXAMPLES OF ABSOLUTE RETURN STRATEGIES?
Absolute Return Strategies vary widely. However, some common examples are as follows:
- Long-short equity strategies: These are strategies that involve a combination of ‘long’ and ‘short’ positions and are generally highly liquid. Examples include long-bias equity, portfolios of paired trades, market neutral equity and short-bias equity.
- Relative value strategies : These are strategies that seek to exploit apparent pricing/ valuation anomalies between particular securities. Typically, the manager will take a ‘long’ position in the security, which appears to be undervalued and a ‘short’ position in the security, which appears to be overvalued. Examples include equity market neutral and fixed interest relative value strategies.
- Event-driven strategies : These strategies involve an assessment by the manager of how company specific events, such as mergers, bankruptcies and restructurings, are likely to evolve. Depending on the exact circumstances, the manager often takes a ‘long’ position in the securities of one of the companies involved, and a ‘short’ position in another. Examples include merger arbitrage and distressed debt.
- Global macro strategies : These strategies involve an assessment by the manager of developments in global economies and financial markets. Sometimes they are driven by the qualitative judgments of the manager. In other cases, the strategies are driven mainly by the use of quantitative models.
- Managed futures funds : These strategies typically use algorithmic3 and technical models that focus on the trends exhibited by futures and other very liquid securities. These include most commodities funds.
- Multi-strategy funds : These strategies use a number of the strategies noted above. As they are diversified across a wide range of different absolute return strategies and asset classes, they aim to deliver consistent returns with low levels of volatility. They are generally managed by one manager, providing a single, cost-effective access point to absolute return strategies.
- Funds of hedge funds (FOHF) : These strategies often invest in 30 to 70 different underlying alternative strategies. What sets them apart from multistrategy funds is that each of the underlying alternative strategies is typically handled by a different manager.