A decade of Absolute Returns

Head of UK retail at BlackRock, Tony Stenning, looks at the evolution of the absolute return sector a decade since its launch.

The absolute return sector has received much attention recently, largely due to the Investment Management Association’s (IMA) decision to review the sector as a result of investor disquiet about the way the funds are structured and sold.

The IMA has put forward plans to incorporate absolute return funds into the revised sectors for the managed sector, which will be categorised by risk profile into four separate areas.

The absolute beginning

The absolute return investment sector was developed in the wake of the introduction of UCITS III, as investors demanded outcome-orientated strategies that were not benchmark driven but targeted positive returns under all market conditions.

Adopted in December 2001, this new legislation authorised funds to use a wider range of investment techniques than traditional long-only funds, while combining this with appropriate risk management strategies.

Absolute return is a definition used to describe the actual amount that an investment makes or loses, rather than relative performance compared to a benchmark. Absolute return funds, therefore, aim to produce positive returns regardless of market conditions.

These strategies aim for consistent returns over the longer term and usually have a strong emphasis towards capital preservation.

They therefore tend to demonstrate lower risk than traditional funds.

Although the legislation for absolute return funds has been in place for a decade, it is still perceived as a relatively new strategy for investors. While BlackRock was among the sector’s pioneers, with the launch of the BlackRock UK Absolute Alpha Fund in April 2005, assets under management in UK absolute return funds have risen to £17.9bn (as at the end of April 2011), or £20.9bn including offshore funds.

The long and short of it

Current regulations for authorised unit trusts prohibit the short selling of physical securities but allow the creation of synthetic short investments through the use of cash-settled derivatives.

This allows absolute return funds to pursue positive returns from a wider range of opportunities than traditional long-only funds, where managers can only make money by picking stocks that subsequently rise in value.

In a traditional long-only fund, a fund manager can only use stockpicking ability and the ability to hold cash to protect the fund against market falls. An absolute return fund manager has the flexibility to create short positions and also to invest up to 100% of the portfolio in cash.

The aim of this is to provide the investor with more stable returns combined with lower correlation to the stock market. Due to this approach however, an absolute return fund is unlikely to capture all the upside in a rapidly rising market.