Page 15 - DIY Investor Magazine - May 2019

ABSOLUTE RETURN FUNDS: MANAGING RISK TO DELIVER STABLE RETURNS AND DIVERSIFICATION
The active vs passive conundrum is likely to remain the most hotly debated topic in investment circles; can active management deliver better investment returns over the long term, net of their higher fees, than low cost passives and trackers? DIY Investor’s Christian Leeming considers absolute return funds.
Fund nomenclature still has a lot of the ‘old City’ about it; but with a little experience it is usually possible to work out from a fund’s title how it is constructed (e.g. equity, bond, balanced) what it aims to deliver (e.g. income, capital growth) or where it is geographically focussed (e.g. China, Emerging Markets, BRIC); but what is an absolute return fund?
Unlike relative return funds, which compare their performance to a particular benchmark, absolute (sometimes ‘total’) return funds aim to achieve a positive return over a defined period of time irrespective of whether stock markets are rising or falling; put simply
it is the actual increase or decrease in the value of an investment.
In a paper entitled The Loser’s Game, academic Charles D Ellis likened the challenge facing absolute return fund managers to that of amateur tennis players; he argued that investing had become so highly professional, that
it was difficult for investors, professional and DIY alike, to perform better than the market average over the long term.
Technology has played a big part in creating transparent and efficient markets, meaning that fund managers can no longer hope to succeed by picking big winners; Ellis contested that success came from playing the ‘loser’s game’, a description he applied to those baseline sloggers that triumphed by dint of making fewer mistakes than their opponents – keeping the ball on the court
and waiting for the other player to put it out when going for a big winner. When applied to absolute return fund management, this approach suggests paying very close attention to risk, although individual managers often have their own ‘game plan’.
‘AIM TO ACHIEVE A POSITIVE RETURN OVER A DEFINED PERIOD OF TIME IRRESPECTIVE OF WHETHER STOCK MARKETS ARE RISING OR FALLING’
Managers employ a range of techniques that traditional mutual funds do not, including short selling, leverage, futures, derivatives and arbitrage; bets that the price of a stock will rise - going ‘long’ - are often balanced by ‘shorting’ those that are predicted to fall in pursuit of consistent returns at potentially lower levels of risk.
Detractors would say that the description as ‘absolute’ implies that the fund is incapable of making losses when in fact it comes with the capacity for loss like any other fund.
WHAT IS SHORT SELLING?
Often associated with hedge funds, short selling (‘shorting’) is not common in fund management outside of absolute return funds.
Shorting is effectively borrowing an asset you don’t own, and then selling it with the aim of buying it back more cheaply when it’s price falls; sell Acme Plc for £1.00, buy it back at 90p, and you’re 10p up, minus any fee agreed with the party that ‘lent’ you the stock.
Short selling comes with more risk than buying a stock, because losses are potentially unlimited, but that is the expertise expected of the absolute return fund manager.
By balancing baskets of long and short positions, the fund performance can be less correlated to overall market volatility; profits or losses in this scenario are delivered by the relative movements in the prices of these underlying stocks rather than the direction of the market itself.
15 DIY Investor Magazine | May 2019