Guide to Absolute Return Investing : Funds in Focus

With new funds the norm in the Absolute Return sector, we asked Defaqto Ltd’s Investment Research chief, David Abbis, to answer some FAQs and for some opinions on how advisers might look at the retail funds on offer within the Absolute Return Sector.

The UCITS III regulatory easing, in 2003 has given the managers of retail funds within the EU to operate derivative instruments within their asset holding and investment strategies. It has also given managers the ability to position cash in their portfolios, not only as a short term holding, whilst the fund manager waits for a suitable investment, but as a positioned asset with a return and a long term strategic purpose.

This means that many Absolute Return funds need careful scrutiny through the official prospectus and fact sheets. What is also clear is that in the absence of historical fund performance, the sector is relatively new, fund manager experience is critical, and most providers make an effort to stress the experience that the firm has in alternative investment strategies, and the experience of the fund manager in the area of Absolute Return.

The Common Ground

All AR Funds follow the same broad objective. To generate positive returns regardless of the relative market conditions. The main purpose of the spate of AR Funds is to avoid the common situation in relative return investments where the benchmark drops to such a degree that even funds which significantly outperform it are of little benefit to investors as they will still have lost capital.

By definition most AR Funds are defensive in structure, and most current portfolios should probably have a defensive fund in them. The question is which. The answer depends on the purpose of the fund, it might be to mitigate risk due to an overweight of a particular asset class or market exposure, or just as a defensive fund designed to create smaller positive returns.

FAQs : Here we cover some common queries about Absolute Return, using two of the Find for IFAs ‘’Funds in Focus’’ to help in the answers.

Q1: Are all Absolute Return funds the same?

A: No they each have different strategies and different investment areas. For example the SWIP Absolute Bond Return Fund invests in Corporate Bonds, Cash and derivatives whereas Standard Life Global Absolute Strategies Fund invests in Global equities and bonds, cash and derivatives.

Q2. What is the same about the funds?

A. They aim to make a positive return from their investments in all market conditions over a medium to long term. A common benchmark is cash plus a certain Percentage. The SWIP fund aims to beat 3 month LIBOR by 3% and the SLI fund aims to beat 6 month LIBOR by 4%. LIBOR is rate at which banks lend to each other

Q3. Do the funds invest directly into equities or bonds?

A. They may do or they could invest into synthetic instruments where the manager “bets” against a fund, stock or index rising or falling.

Q4. I invested in sterling, will all the investments be the same?

A. No, the manager will invest in other currencies but it is usual that any currency risk will be hedged to ensure there is not a loss. This is a particular point to query.

Q5. I believe that Managers can “borrow” stocks and sell them to gain a better return for me, do either of these funds do that and how can I find out.

A. Yes that is true and both these funds are able to invest in this way. The monthly fund factsheet that is available from the manager’s website show the long and short positions and in the case of SLI they show how any currency is protected.

Q6. Is my investment guaranteed?

A. No, there is no guarantee for either income or growth.

Q7. I am told that fund prices are very low at the moment, would I get a better return on my money if I invested in an equity fund or a tracker?

A. Over time fund prices will rise as will indexes so yes trackers and equity funds may go up quite a lot. The absolute return funds will not necessarily go up as much over the long term as they aim to make a return in all markets but they will not necessarily be big returns.

Q8. So how can the manager make a positive return when stock markets are falling?

A. By investing in derivatives and different instruments related to equities or bonds that have other sources of return. By investing in a wide range of instruments the manager can spread the risk which may limit the return.

Q9. Are the funds run by just one person?

A. No. Just one person may be named but in most cases and certainly at SWIP and SLI there are large teams of experienced people supporting the managers. The supporting teams will have their own responsibilities but will advise on investments in the various parts of the world, whether equity, bond or currency and also in the other instruments available to maximize a return and to minimize risk.

Q10. Can funds hold a lot of cash?

A. Usually unit trusts can only hold a small amount of cash but absolute returns can use cash as an asset class. That means they can invest in cash in the same way as equities if the manager thinks there will be a better return. At the end of December 2008 the SLI manager was holding 38.6% of the fund in cash and the SWIP manager had nearly 60% of the fund in cash at the end of March.

To view the SWIP Adviser Microsite, download factsheets, register for the Academy, an here educational details on SWIP Funds Click Here

To view the SLI Adviser Portal, featuring Focus on Funds, GARS, Strategic Bond Fund, and AAA Income Fund, House Views, How to Invest and much more. Click Here

If you would like to receive further educational guides from Find for IFAs or our sister firm Defaqto Limited, then please email us: find@find.co.uk