How do Absolute Return Funds work?

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Published Tuesday, May 20th 2008

What is a focus fund or target return fund? I understand most fund managers simply manage money to outperform each other?

Indeed you may well be correct. It reminds me of the two chaps who are walking through a jungle and hear a tiger. One stops to put his trainers on and the other laughs and says he won’t outrun a tiger. The other responds that he isn’t trying to outrun a tiger and that he is trying to outrun him.

Many funds are managed in this lethargic approach. Their aim is generally to outperform the competition, so as a consequence they typically hold similar sorts of stocks and similar weightings in geographical areas. I am sure this is not what you thought you were paying for.

The funds are quite restricted in that respect. In many ways they are forced to do this as they are so large. It is quite difficult to manage a fund with £4 billion worth of stocks. If you hold 100 stocks, this is an average of £40 million in each fund. How can you sell off this amount of cash without the share price crashing as you are doing it?

In reaction to this, many of these managers will simply hold large positions in stocks they believe will always do well.

They keep a very simple structure to their fund, and just try and outperform the fund behind it. If the market is going down, they are not in a position to sell the stocks and so you follow the market down.

Total return and ‘absolute’ funds are supposed to aim to avoid this.

Their aim is to produce a positive return no matter what the market does, or alternatively, a return over cash no matter what the market is doing over a set period of time.

I am sure this is the general expectation of most investors.

Absolute return funds are complex in their nature. They can take short positions in a market to benefit from it if it falls. This means they basically bet that it will fall. This can be very useful if they believe they are in difficult times, as they can make large amounts of money if the market falls.

They are interesting to many investors because of this headline attractiveness, but as always, keep an eye on a number of issues.

You know the risk with touching a wasp or caterpillar. Putting your hand in a bag of moving animals carries with it an added risk. Consider that unconventional solutions carry unconventional risks and you will understand what I mean.
It is not enough for financial advisers to discharge their liability by allowing the above managers to fulfil an obligation their marketing literature states is ‘good’. There can be considerable noise in these arrangements and it’s an adviser’s job to see through that.
Let me explain: A fund that is aiming for a steady, but long term growth will sacrifice some short term gains in pursuit of that. On top of this, the aim to ‘produce market returns in all market conditions’ are not guarantees.

A bet that the market will go down could be wrong as the market could go up. This will all be down to the skills of the manager to decide what they believe the market will do, something many haven’t really been able to prove.

A target return fund can be useful however in that they can make quick decisions on markets and move swiftly, making tactical asset allocation decisions that the above clumpy funds cannot. If they believe that Europe is a bad place to be they are happy to move and take that bet. The companies most of us are invested into could not do that.

They can however have larger price tags, so be careful which you choose.

For a list of the better Absolute Return Funds call Worldwide free on 0800 0112825 or email and take a look at our section on Investment.

The value of shares and investments can go down as well as up

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