How risky are Absolute Return Funds?

King_Weasel

I haven't done a thorough survey, but the few sites I have looked at seem to regard Absolute Return Funds as relatively low-risk, or "cautious". I believe they try to deliver positive returns in adverse environments by short selling. But I doubt any advisor would recommend this strategy to the ordinary investor, so why is this considered safe for a fund manager? No doubt he can do it better, but doesn't it remain a relatively risky investment strategy?

I also understand these funds are fairly flexible in where they invest. Fine, but again why should this be inherently safe? Surely this depends (a) on the competence of the manager and (b) on the risk policy the fund chooses to adopt.

dunstonh

How risky are Absolute Return Funds?

They vary from quite low risk to quite high risk.

But I doubt any advisor would recommend this strategy to the ordinary investor, so why is this considered safe for a fund manager?

If the client in question understands how they work then there is no harm recommending them. Fund managers will often include assets and investment instruments that a personal investor wouldnt use themselves. It all comes down to understanding and making sure the possible asset spread and type of assets is consistent with the risk profile of the individual.

My belief is that absolute funds have moved from a niche area to become a fashion over the recession. Its always risky when a niche investment becomes fashionable.

Reaper

It does indeed depend entirely on how good the fund manager is. Much more so than most standard funds.

While in theory they claim to make money on rising and falling markets I would suggest they are best when you think the stock market is in for a lengthy bad patch. Since they were launched the markets have been doing relatively well and the Absolute Return funds have fared poorly compared to normal funds.

Linton

"Absolute Return" does not seem to be a well defined term. Some funds have been wildly unstable - see Octopus. On the other hand, apart from an understandable temporary blip in 2008, the Newton fund seems to have provided the "safe" steady returns one might like.

Another factor is that this is a new sector. There is only limited long term data.

So if this is the sector you want I suggest you look at each candidate fund individually very carefully.

sabretoothtigger

Its just an idea and a trendy one that they know how to avoid major losses. Its as risky as anything else, devil is in the detail. There is no way to eliminate risk, cash wont do it either

purch

It is often 'assumed' that these type of Funds are lower risk, due to their mandate which is normally to generate a positive return in any market.

The problem is, the methods they are required to use to achieve this return are high risk.

More than probably any other type if Fund, you are relying on the skill and expertise of the manager, or management team.

jamesd

It depends entirely on the fund. I've seen some using an objective like "to make an absolute return over a whole economic cycle". Hard to conceive of any fund manager, for any type of fund, who doesn't have that as a minimal easy to achieve objective, since it merely means not losing money, before inflation, over about seven years. Any bond fund should easily be able to do this.

Others aim not to drop much over shorter times and are potentially more useful.

Loughton_Monkey

An 'ordinary' fund tends to invest mainly in tangible assets (shares, bonds, property...).

An 'Absolute' fund also includes 'derivatives'. There will be a complex mixture of futures, options, stops that are designed to ensure that (for example) that the fund is tending to 'short' when the market turns downwards.

Not sure I would use the term 'riskier' with these. My understanding would be that such a fund would be much less 'volatile' than others. It would certainly not go up as much as a 'raw' fund with a similar focus. But won't go down as much either.

I suspect that technically there could be an additional risk. That would be (a) the fund manager failing to 'design' it properly to the extent that a specifically unusual situation might 'blow' it, and (b) the supplier of the 'derivatives' could well go 'belly-up' leaving the fund with either massive losses or a dangerous exposure.

Just to give an over-simplistic example:

1. You invest £1,000 directly in a $US Share. It goes up by 10% in a year. You have 'made' 10%. But the $US is 'down' by 5% so your fund is only worth £1,050. If the $US had gone the other way, you might have got £1,150.

2. I invest £980 in the same $US Share, but additionally spend £20 on a 'future' which ensures that if the $US goes 'down' I am protected. If it goes 'up' then I enjoy the benefits. So in the first scenario my £980 will go up the full 10%, giving me returns of £1,078. If it goes the other way, I will get the full 15% meaning return of £1,127.

So from the perspective of currency, you might have 'lost' £50 or 'gained' £50. In my case, I could have 'lost' £22 or 'gained' £27

So now you can see how some 'options trading' on the share itself may serve to narrow the volatility as well.

bendix

Absolute return is such a crock of a term. Yes, they are absolute return in that they . . umm . . absolutely provide a return. Sometimes it's negative. Sometimes it's positive.

So what is the point of the name?

jamesd

Some of them do use techniques that reduce volatility and perhaps risk also. Blackrock's UK Absolute Alpha fund is probably the best known consumer fund of this type. A lot of the drop it suffered in 2008 was due to the manger still having some long interest in a high oil price. Not the right thing for that time.