An absolute return strategy aims to meet a target while managing volatility at the same time, explains Charlotte Moore in part one of our investigation into the investment strategy

In recent years, trustees have become increasingly interested in funds that provide ‘absolute’ returns. The popularity of these funds is closely aligned to pension schemes’ wish to generate strong returns while keeping a lid on volatility.

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These investments can match that profile but there are no guarantees every absolute return fund will meet these targets. Trustees need to look under the bonnet of the fund to ensure it meets their requirements.

What does ‘absolute return’ mean?

Absolute return is a classic investment marketing term – it’s easy to remember but subject to a host of different interpretations. Too frequently, investors think the term absolute implies that returns on the fund will always be positive. But this is not always the case.

Robert Howie, principal in the alternatives boutique of Mercer Investments, says: “Funds with an absolute return target aim to achieve positive returns but sometimes the strategy is not successful.”

A better way is to think of it as an approach that is purist in its pursuit of a particular investment strategy. Matt Siddick, hedge fund research specialist at Aon Hewitt, says: “This type of strategy achieves its returns because of manager skill – they are very actively managed funds.”

Instead of linking a target to a particular benchmark, these funds often aim to generate better returns than cash or to beat inflation. The target is usually to deliver a specific absolute annual return over a specific number of years. Malcolm Jones, investment director of absolute return and multi-asset investing, Standard Life Investments, says: “We target an annual return of 5% above cash on a rolling three-year basis.”

Crucially, says Siddick, these funds do not base their return targets on market-based proxy, like the FTSE 100. This allows a manager to ensure that each component of the fund is selected because it meets the requirements of the investment philosophy rather than ensuring the fund does not deviate too far from the performance of its target.

These funds aim to deliver attractive returns, irrespective of market direction performance. Funds can achieve this either by varying market exposure, employing a market-neutral approach or through a multi-asset allocation. These characteristics mean the funds are typically being less volatile than more traditional equity investments.

How they achieve their aims

While all absolute return funds are actively managed strategies, there is a huge variation in how they do this.

Many of the traditional hedge fund strategies fall into the absolute return camp, such as long-short equity funds. Multi-asset strategies can also be defined as absolute return funds. Howie says: “An absolute return fund can also be a long-only equity or fixed income manager who selects specific stocks but does not aim to beat a reference benchmark.”

Any strategy that uses real active manager skill to generate a return that is not based on the direction of a market can be employed in an absolute return fund.

 To find out more about how to fit absolute returns within a portfolio, read part two of our series here