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Absolute-return funds - a safe haven?

Absolute Return investment funds have been extremely popular with investors. According to the Investment Management Association (IMA), net retail sales in 2009 were £2.55 billion, making it the second most popular sector behind UK Corporate Bonds.

An absolute return fund is one which aims to deliver positive returns irrespective of whether the market is going up or down. However, it is important to understand that one absolute return fund is not necessarily like another. Different funds can adopt vastly different approaches. Some funds will invest into a wide range of investments, others will make calls on currencies and interest rates and others will look to 'short' investments. Shorting is a common practice in the hedge fund industry where the fund manager sells investments they don't actually own. This means they make money if the investment falls in value but lose money if it rises.

It is also important to understand that while these funds are called absolute return that does not guarantee they will make money for you. In the past 12 months the average absolute return fund returned a credible 11.3%. However, in the previous 12 months the average fund actually fell by 1.9%.

As they have become more popular, investment companies have been launching new funds. In the last year we have seen top rated fund managers such as Philip Gibbs at Jupiter and Roger Guy at Gartmore launch new absolute return funds. They join other top managers such as Mark Lyttleton at Blackrock and Tim Russell at Cazenove. We can expect more to follow.

The major reason investment companies are so keen to launch absolute return funds is because they charge higher fees to manage them. They have the usual initial and annual management charges as you would expect from a managed investment fund, but also include a performance fee.

This performance fee is generally 15 to 20 per cent of any out-performance over a set benchmark. Common benchmarks include UK base rates or Libor, the inter-bank lending rate. Both of these rates are significantly below 1 per cent per annum and so the fund manager effectively earns a performance fee on any gains they make.

While potentially high charges can impact on overall performance and past performance is not a reliable indicator of future returns, we still believe that absolute return funds can have a role to play in a client portfolio. They can provide valuable diversification benefits as they can make money when markets are falling and, if care is taken when selecting investment funds, they provide access to some of the best fund managers in the industry.

Article provided by AWD Chase de Vere Wealth Management