Are absolute return funds a better way to invest in an uncertain world?

Absolute return funds have been a popular choice among investors over the past few years. Political instability, uncertain monetary policy, stretched market valuations and heightened volatility all have drawn investors to funds that generally aim to keep volatility low and deliver positive returns in all market conditions.

Absolute return funds usually use investment strategies that differ from traditional funds and are more commonly associated with hedge funds. On top of this, despite sharing a similar broad objective, funds in the sector vary considerably on the ways they achieve it.

Some invest only in a single asset class, such as equities or bonds or geographical region. But many are multi-asset funds, with holdings in equities and bonds as well as in commodities, currencies or property. These funds are usually global, allowing them to invest in assets around the world.

In terms of strategies employed, they can be long/short, market neutral or global macro funds that can blend a number of different investment strategies and assets together, making multiple bets on a broad range of assets as each strategy is likely to perform differently at different times of the economic and market cycle.

How to pick the right absolute return fund for you

Absolute return funds also extensively use derivatives, currency hedging and other complex investment techniques that help to reduce volatility and preserve capital. A typical absolute return strategy is design to deliver equity like returns with half the volatility of equities.

One of the implications of these wide differences between funds is that their risk levels can vary widely: some aim for a cautious risk-return profile; while others are prepared to be more adventurous.

As well as being one of the most popular among investors, the sector has been subject to a lot of scrutiny. As investors continue to buy these funds, their performance has been less impressive of late.

For example, some funds are so cautious that they struggle to deliver returns better than cash, while others are very aggressive and far more volatile than you would expect for this sector.

In 2013 the Investment Association added the word 'Targeted' to the previous designation of the 'Absolute Return' sector to ensure there is no doubt that positive returns are a target and not guaranteed.

Investors are concerned that absolute return funds are usually very complex and difficult to understand and some have unrealistic objectives along with high fees. All of this has attracted the attention of the FCA. The regulator said that it going to investigate the sector as part of its review of the asset management industry.

Absolute return funds may be a useful way to diversify your portfolio and protect capital over the longer term. As they often hold alternative assets, they are less correlated to other asset classes such as equities or bonds. This means they may perform differently at times of market volatility, potentially helping to offset losses in other parts of your portfolio.

By using sophisticated investment strategies such as short selling or pair trading they can provide consistent returns with less volatile performance than traditional funds, especially during market sell-offs.

Absolute Return funds are probably more suited for more cautious investors who cannot cope with the volatility of equities. They can also be used for capital preservation strategies that do not require high returns.

A further use might be for pension portfolios for investors near retirement who want a stable income and are less concerned about maximising capital returns.

If you'd like to add an absolute return fund to your portfolio, there are a number of good options that investors might consider. These include the Henderson UK Absolute Return, Fulcrum Diversified Absolute Return, Newton Real Return and Premier Defensive Growth funds. The latter two are Money Observer Rated Funds.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.