Absolute return funds

Steadier results through a combination of strategies

In the current investment climate, absolute return funds could offer the ordinary investor access to a range of more sophisticated investment techniques previously only available to the very wealthy.

These products, which have only become generally available in more recent years, aim to provide a positive return annually regardless of what is happening in the stock market. However, this is not to say they can’t fall in value. Fund managers stress that investors should not expect the funds to make money for them month in, month out, but over the medium term – five years – they should produce positive returns.

Invest in a wide range of assets
Absolute return funds achieve their steadier results through a combination of strategies. One strategy is to invest in a wide range of assets, including not only shares, bonds and cash but also the likes of property and hedge funds. Another is to use derivatives, which are specialised products that allow investors to bet on the future price movement of an asset. Crucially, this allows investors to make money when an asset is falling, as well as rising, in price. To make money in a falling market, absolute return managers can make use of sophisticated investment tools such as ‘shorting’ and ‘credit default swaps’.

Used properly, these tools aim to allow absolute return funds to do better than straightforward equity or bond funds when markets are falling. However, they are likely to lag behind their more conventional rivals when markets are rising.

Preserve wealth, in good times and in bad
Absolute return funds have a broad appeal and a place in many investors’ portfolios because they aim to do what a lot of investors want, which is to make money and preserve wealth, in good times and in bad.

For the more adventurous investor, absolute return funds could be used as the foundation of a portfolio while buying more aggressive funds alongside. Alternatively, for more cautious investors they could provide a foundation for a more conventional portfolio. However, it is vital that investors choose carefully and obtain professional advice before entering this market.

Building a balanced portfolio
Absolute return funds do not rely heavily on a rising market for their success, rather the skill of the manager. They are therefore a true diversifier and could also be an important tool for building a balanced portfolio that grows over the medium to long term.

Unlike hedge funds, absolute return funds are fully regulated by the Financial Services Authority and investments in them are covered by the Financial Services Compensation Scheme, providing they are based in the UK.

Investors in absolute return funds are principally liable to Capital Gains Tax (CGT), which is charged when you sell an investment and realise ‘gains’ (profits) above a certain level. Current CGT rates are 18 per cent or 28 per cent for basic and higher rate tax payers respectively. In addition, every investor can also realise £10,600 of profits in the current 2011/12 tax year without having to pay CGT.