December 30th, 2011 by Citywire Research Team

Absolute Return: winners and losers

With absolute return portfolios growing in portfolio, how can you separate the good from the ugly? Top managers share their experience over the past year with Citywire Global.

Marta Campello, Abante Asesores

Investors ask for positive returns and low volatility in any market conditions. Since we have experienced a prolonged spell of volatility they are looking for shelter in so-called absolute return funds, but they do not show a clear preference for a specific type of absolute return.

In fact, it does not matter if it is a global macro, market neutral, flexible beta or any kind of arbitrage, to mention just a few – they just want good performance and consistency while they look at equities from the corner of their eyes.

The recent financial crises have become more of a stress test for absolute return managers than any fund analyst could have imagined.

From a fund researcher point of view we cannot be happy with the absolute return funds as a whole. Some good managers are beginning to think they are losing their skills, as this market is playing havoc with their track record. There are, nevertheless, very good managers who are able to cross these turbulent waters while protecting their boat from sinking.

Some examples of good performance in this environment are Dexia Index Arbitrage, GLG European Alpha Alternative and Abante’s Maral Macro. The latter has returned 3.96% since launch in June this year.

Miranda van Rensburg, Absa Investments

Absolute return funds have gained in popularity, partly due to the move towards multi-asset class funds away from speciality funds.

But increasingly this trend is due to investors becoming more savvy in their financial planning. Gaining wealth in absolute terms is preferred to merely beating some benchmark which itself is still losing money.

However, absolute return funds’ performance has diverged. In the South African market it appears that those funds which achieve their goal through strategic and tactical asset allocation have outperformed those that rely on the use of derivatives for protection. This could relate to the pricing of options and other derivatives which has risen due to increased share price volatility.

Any explicit guarantees provided are also expensive – thus while protecting on the downside investors are not always achieving the returns they desire. Time will tell whether (besides pure manager skill) asset allocation or the use of other protection strategies will achieve the best results in absolute return funds.

Lionel Henrion, Delta Lloyds

Alternative investment strategies cannot be entirely replicated through traditional investments in other asset classes. Therefore, those strategies will improve the risk/return profile of a portfolio.

Now, investors have to be aware not only of their risk aversion level, but of their risk definition. If investors accept a lower return most of the time they will be able to find some funds that really bring protection and prevent huge loss in extreme environments.

This is the way we see alternative investments. The classic market neutral strategy is the best example; some arbitrage strategies may also play that role, and did very well this summer. The problem is that the pressure of sticking to a low-return fund in a bullish environment is more difficult than it appears.

Investors are often tempted and switch toward more directional exposure or opportunistic strategies whose correlation changes more quickly, mostly during extreme circumstances.

This being given, investors still have to find a suitable manager in the selected investment strategies – a manager able to stick to his process whatever the conditions, who will avoid behavioural bias such as myopic loss.

Montserrat Formoso Fragua, Tressis

An absolute return approach has more to do with asset allocation, risk control and fund picking than a focus on a specific product.

Asset allocation can help ensure a portfolio is flexible enough to adapt to any substantial market change or to reposition itself when any decision is not working properly.

Other factors to consider include opportunity costs, as investors get similar returns to directional products in down markets, but less performance in up markets. Secondly, daily liquidity has damaged returns in some strategies that were obtained with less liquidity. Finally there is the issue of carry: with interest rates near zero, risk needs to be higher in the portfolios to obtain the objectives assumed.

This article originally appeared in the December 2011 / January 2012 edition of Citywire Global magazine

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