Absolute returns and convolute concerns

The key questions are predicated on the disparate nature of the funds that inhabit the sector. The waters have been muddied by a slew of new fund launches over the past year, each with a mandate that does little to bring any homogeneity to what increasingly looks like a cobbled-together grouping.

Initially, the whole point of absolute return funds was that their managers would not be benchmark- or exposure -manacled but, instead, would seek to generate a steady return that exceeded that of cash deposits in varying market conditions. We have certainly seen markets careering through mayhem in the past 18 months or so, and these are exactly the conditions in which investors could expect their absolute return fund managers to step up to the plate and show their mettle. This brings us to the first of our key points.

According to Financial Express, the sector's average return, over the 12 months to 25 June 2009 - a period when the FTSE All-Share index plummeted by more than 21 per cent - has held up relatively well, posting a loss of just 2 per cent. But this encompasses a wide range of outcomes for individual funds. Investors in EFA's Absolute Return Portfolio would have seen an 11 per cent haemorrhage from their fund, while those who bought into CF Octopus Partner Absolute Return could celebrate a 41 per cent gain over the same period.

Which raises another concern, and it does call into question the whole concept of 'absolute return', as well as whether these funds are living up to their investment objectives. In those two polar opposites, we can see that the sector lacks any unifying theme, least of all the idea that, however they go about it, navigating a steady course through turbulent markets is their raison d'être. This is something that investors will need to investigate through their advisors before committing to a member of this sector.

The reason is not just because some of these funds simply do not live up to their remits; it is perhaps more importantly linked to the fact that, in pursuit of their objectives, the variety of strategies employed brings its own set of caveats. We have pointed up the least successful performer in this grouping, and its stated purpose is to use a whole range of collective investment schemes, along with money market instruments and derivatives. That is quite an armoury, but it didn't deliver many bucks for the bang.

By contrast, Octopus takes what seems to be a more straightforward long/short approach. Overweighting short positions can not have done any harm in the period since late 2007, and this is arguably what lies behind the fund's prominently positive performance. Also arguable is the point that neither of these outcomes is the point. What investors should be looking for here is a smooth path, with a steady better-than-cash return, and a negative correlation to what is happening when either misery or irrational over-exuberance is stalking the markets.

It's all very well churning out a 22 per cent gain - as Schroder's SISF Emerging Markets Debt Absolute Return fund did in the year to date - but not so heart-warming when the same vehicle drops around 3 per cent in the past three months, just at a point when conditions could be expected to be easing. The answer for investors is to examine each fund in this sector carefully, to assess its performance over longer and shorter terms, and to understand and be comfortable with their investment strategies.