Absolute returns beefed up by global credit crunch

The combination of diversification, alternative investment and active fund management strategies, are delivering positive returns in spite of these adverse market conditions.

James Fairbairn, GAM portfolio director, says the asset manager has maintained its more cautious positioning towards equities, adopted since mid-July, both on a tactical and strategic basis, given concerns that contagion driven by sub-prime might spread to the broader economy.

“However, the shift in global monetary policy has enabled both bond and alternative investment managers (presently 45% of GAM's Absolute Return strategy) to profit from both trends and volatility in non-equity assets, which has limited the impact of equity market weakness for GAM's Absolute Return clients,” he says.

Similarly, according to Hugh Adlington, investment director and chair of the asset allocation committee at Rathbone Investment Management: “The dislocation in most mainstream liquid markets and massive dispersion returns erupting we’ve seen over the past quarter have given opportunity for genuine active managers and hedge funds the ability to make returns without much directionality. In effect, they can make positive returns despite the fact that markets are generally heading south.”

He says that’s probably the first time we have seen that for three or four years because compared to previous market corrections, such as in April and October 2005, and May 2006, when pretty much everything went down at the same time. Consequently everything was totally correlated and therefore diversification didn’t work.

“Now actually diversification is working very well and that’s why you have been hearing about some hedge funds in the States, which were short of sub-prime, and which have been making an absolute fortune."

"Effectively they have been paying small premiums every month to be on the short side of an increasingly good looking trade. Then when sub-prime blows up and you’re short of it, and everyone else is long of it, you are likely to make a lot of money,” he says.

It’s difficult to generalise about absolute returns and their strategies as a single entity because there are so many different vehicles and ways of achieving a positive. Furthermore, some of those vehicles that were doing well in the past are not doing so well now, such as credit spreads.

Steven Richards, investment manager at Thesis Asset Management says the past year has typically seen a rising interest rate environment, in which the majority of Absolute Return style funds have struggled against cash, whereas Hedge Funds or Fund of Funds appear to have performed the best.

“We however, are more interested in their risk:return profile than beating cash per se, as we are of course aware that cash is taxable to most investors whilst the returns from investment vehicles, even if not ahead of cash, may be worth more,” he says.

Nevertheless it is positive returns that really count.

“Some of the close-ended fund of hedge funds have been making returns of 10-15%, which is exactly what you want from an absolute return strategy, doing exactly what it says on the tin regardless of market direction,” says Adlington.


1 December 2007