Absolute return funds aim to generate positive returns regardless of market conditions through the use of alternative investment strategies. As investors seek diversification and reduced volatility, these funds have grown in popularity. However, their performance can vary significantly across providers and strategies. This article evaluates the performance of absolute return funds from leading alternative investment partners.
Factors driving investor interest in absolute return funds include the funds’ low correlation to traditional assets, expanded opportunity set, and potential for positive returns across market cycles. Moreover, absolute return strategies allow fund managers greater flexibility in utilizing techniques like short-selling, leverage and derivatives. However, the wide range of strategies and lack of benchmarking create challenges in assessing fund performance. Investors must conduct rigorous due diligence.
To deliver consistent uncorrelated returns, top absolute return funds utilize skillful asset allocation, exploit market inefficiencies and incorporate strategies like global macro, long/short equity, managed futures and fixed income arbitrage. Understanding how these levers are applied provides insight on performance drivers.
Market neutral and arbitrage strategies aim for steady returns but have limitations
A common approach among absolute return funds is to utilize market neutral strategies that remove broad market exposure, along with arbitrage strategies that aim to exploit pricing discrepancies. These strategies can produce steady returns uncorrelated to equity and bond markets. However, they also have limitations.
For example, equity market neutral funds take offsetting long and short positions to neutralize exposure to overall market moves. In theory, profits are generated from stock picking skill. However, market neutral funds struggled during periods like the 2008 financial crisis when correlations across stocks spiked. Funds suffered losses when longs fell and shorts did not provide adequate hedge. This highlights the inherent challenges of delivering true market neutrality.
Fixed income arbitrage funds aim to take advantage of temporary mispricing between related securities. But pricing anomalies can persist for longer periods than expected, leading to losses. Also, it takes specialized expertise to properly identify and capitalize on complex arbitrage opportunities. So while market neutral and arbitrage strategies have a place in absolute return funds, managers must skillfully implement them.
Global macro strategies provide diversification but depend heavily on manager skill
Global macro strategies are a key part of many absolute return funds’ toolkits. Global macro involves trading a broad range of instruments – stocks, bonds, currencies and commodities – based on top-down analysis of macroeconomic trends and policy shifts. These funds generated strong crisis-era returns as managers capitalized on themes like the housing bust and policy responses.
The flexibility of global macro provides valuable diversification. But performance is heavily dependent on manager skill in identifying macro themes and expressing them through optimal instruments. Weak returns can result from low market volatility, unclear trends or simply subpar decisions. So while global macro expands opportunity, its success hinges on manager talent – leading to wide performance dispersions.
Long/short equity funds offer equity market exposures while mitigating risk
Equity long/short strategies take both long and short stock positions, providing equity-like returns with lower volatility compared to traditional stock funds. The short positions help hedge against market declines. Top long/short funds leverage diverse alpha sources – combining fundamentals, technicals and quantitative signals – to make long and short selections.
However, performance depends heavily on stock-picking skill and shorts not keeping pace in rallying markets. Also, funds struggled when correlations rose during the 2008 crisis, diminishing the effectiveness of hedges. While long/short equity is a major absolute return strategy, investors must identify skilled stock pickers – particularly on the short side.
Managed futures funds can provide crisis-era diversification but introduce volatility
Managed futures funds trade commodity futures, currencies and global interest rates based on price trends and other quantitative signals. These strategies generated strong 2008 returns by capitalizing on trends across hard assets, providing diversification when most assets declined. However, managed futures exhibit higher volatility as deep losses can occur when market reversals whipsaw funds’ trend-following models.
Funds must avoid overcrowded signals and balance trend-following with mean reversion strategies. Performance is path-dependent, so strong periods can be followed by extended drawdowns as models readjust. While managed futures diversify portfolios, investors must accept their volatile return patterns and not abandon them during temporary downturns.
Fixed income arbitrage strategies offer steady gains but must adapt to central bank policies
Many absolute return funds implement fixed income arbitrage strategies like yield curve trades, capital structure arbitrage and ABS/MBS relative value. These funds exploit temporary pricing inefficiencies between related fixed income securities to generate steady gains. However, central bank policies have repressed volatility and compressed spreads, challenging many historical arbitrage relationships.
Top fixed income arbitrage managers adapt their models and take measured risks to safely extract excess returns in today’s environment. They focus on complex, less efficient segments like securitized credit. While fixed income arbitrage makes up a smaller share than past periods, it can still generate uncorrelated returns with disciplined execution.
In summary, absolute return funds utilize diverse strategies – from market neutral to global macro – that can produce steady gains across market environments. However, performance is highly dependent on manager skill. To identify top performers, investors must assess managers’ expertise in their strategies, risk management capabilities, and ability to adapt to changing market conditions.