Absolute Return Strategies

Absolute Return Strategies

Absolute Return strategies are investment strategies that endeavour to generate positive returns regardless of market conditions.  Conceptually absolute return strategies resonate well with investors as most investors view risk as the risk of losing capital.

The basic premise of an absolute return strategy is to generate “equity like” investment returns with less risk.

The absolute return universe

The absolute return universe can be broadly broken down into the following five strategies, namely; Equity Long/Short, Market Neutral, Relative Value, Global Macro and Managed Futures.

Equity Long/Short Funds

An equity long/short approach allows investors to benefit from both the rise and fall in the value of companies.  This strategy differs from a traditional investment portfolio in that it has the ability to take short positions in companies in which it believes its share price will decrease.  It can then use the proceeds from these short positions to take further long positions in companies in which it believes the share price will appreciate.

Long short funds typically have mandates that either have:

1. a fixed long short composition (for example where long/short exposure is 130/30 or 120/20), or
2. the ability to vary their net market exposure (beta variable funds).

Market Neutral Funds

A market neutral fund is an essence an equity long/short fund that typically maintains net equity market exposure no greater than 10% long or short.  As short positions fund short positions, market neutral funds sit on a lot of cash.  Their investment performance largely depend on the fund manager’s stock picking abilities.

Global Macro Funds

These strategies are predicated on movements in underlying economic variables and the impact they have on equity, fixed income, currency and commodity markets.  Global macro managers employ a variety of techniques over long and short term holding periods.

Managed Futures Funds

Managed futures strategies have investment processes that are driven by quantitative models and have little or no discretionary influence.  They seek to exploit investment opportunities in markets that exhibit trending or momentum characteristics across individual instruments or asset classes.   Asset classes include equities, commodities, currencies and bonds. 

As the name suggests managed future funds trade in futures.

Relative Value Funds

Relative value is an investment strategy that endeavours to take advantage of price differentials between related financial instruments by simultaneously buying and selling the different securities.  The strategies will typically hold long and short positions in equities, fixed income and derivative securities.

Our comments

Absolute return strategies are often used to help diversify a traditional long only portfolio although they can be used on a stand-alone basis.  In our opinion many of the most talented portfolio managers reside within the absolute return sector.  Although the financial industry refers to fixed long short funds as an absolute return strategy, we do not.  This is because we believe they are not structured to generate a positive return in a materially falling market. 

Advantages of absolute return strategies include the provision of uncorrelated investment returns and strong downside protection during periods of equity market weakness.

The vast majority of absolute return funds are unregistered managed funds and are only available to wholesale investors.  Unregistered managed funds typically have investment minimums of $250k to $500k.