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Should You Invest In Hedge & Absolute Return Funds At All?


In recent years, the fund sub-sector seeing the greatest inflows has been the Multi-Asset Absolute Return sector. Somewhat ironically, it has also been the sector facing some of the most intense criticism.

Absolute return funds share many similarities with hedge funds. Like hedge funds, they aim to deliver positive returns in all market conditions, and have the freedom to pursue any variety of investment strategies, complex or otherwise, in pursuit of that goal. They differ to hedge funds in that they are more regulated, more transparent, more affordable and, thus, more suitable to the average retail investor.

When done well, the hedge/absolute return style of investing is perfectly in tune with the way most people want to invest; consistent, predictable returns, compounded over time, where the capital value is not subject to large swings. The trouble is that across the absolute return landscape, only a small proportion of managers can claim to have consistently delivered on these expectations over extended periods of time.

And the investing community has not been shy in voicing its discontent. The regular detractors bemoan lacklustre returns, while the most vocal critics go as far as to question the very concept of absolute return investing itself, and whether the idea of consistent positive returns with low volatility is even plausible. They contend that investors are being sold a "have your cake and eat it too" pipe dream that frankly can't be achieved. The criticism is not without merit, and while investors should be made aware that an investment in hedge/ absolute return funds does not automatically grant that capital immunity from decline, there is a strong case to be made that now would be an unwise time to abandon the space altogether.

Since World War II, the S&P 500 Index has experienced ten distinct bear markets, with an average time frame between periods of five years. The current market rally has persisted now for eight-plus years, making it the second-longest period without a negative twenty percent decline since the Great Depression. The duration of this market rally, combined with historically elevated asset valuations and record levels of margin debt strongly suggests that now is a good time to seek out strategies designed to protect capital in difficult markets. Active managers' ability to dynamically deploy capital at different points of an economic cycle have enabled them to perform this role in the past, suggesting absolute return strategies may have an important role to play in the near future.

The most important factor for investors is choosing the correct fund for them, or more specifically- the correct fund manager. Given the diversity of the sector, where funds with similar sounding titles pursue very different objectives, that is easier said than done. Historical precedent can be a good place to start; for example, investors with a preference for capital preservation might consider funds with strong track records through recent bouts of market turbulence (e.g. the taper tantrum of 2013; China slowdown fears in early 2016). Lesser-known investment houses should not be discounted either, where you can find managers with particular specialties and who will actively own the investments they are endorsing for clients in a personal capacity. The key message is that investors must look under the bonnet of hedge/absolute return funds and understand how that fund can or can't be expected to fulfil its required role within an investment portfolio.

If that sounds too cumbersome, (or if absolute return investing sounds like an absolute waste of time!), then a traditional multi-asset fund - made up of cash, government bonds and equities - can do a fine job for less effort and (probably) a better night's sleep.


Diarmuid Broderick 
Investment Advisor 

18th August 2017