While there are several different processes that can be used to achieve an absolute return, from a philosophical point of view, investors should realize that there is no such thing as a riskless asset class. All asset classes, including cash, bear risk.
According to Adrian Saville, CIO, Cannon Asset Managers, the only way to deliver an absolute return is if you have a process to forecast returns with absolute certainty. Sadly for asset managers and investors alike, such a tool does not exist (other than in theory or fantasy), one must therefore produce an absolute return derived from a relative return.
The only way to achieve this is by means of a market neutral fund. Despite this, a scan of the environment reveals than many of the so-called absolute return funds are conventional long-only funds (or close relations). It’s really hard to reconcile a long-only fund as being an absolute return fund.
An absolute return fund should be expected to produce steady, pedestrian returns through all market conditions. The returns shouldn’t be lumpy – that would imply that they aren’t consistent through all environments. Yet, when market conditions have been poor, returns in the absolute return arena have crumpled.
For instance, in January this year we saw the average hedge fund return -2.5%. While that may be better than traditional funds, it’s not satisfactory if you are looking for an absolute return.
There is also a problem regarding time horizons. Many absolute return funds target their returns over a three or five year period. However, if you were to take risky asset classes over the same periods, there is a very high probability of them producing an absolute return.
I think that there are two main problems with these funds. The first is that the opportunity costs can be high. If an investor accepts the potentially mundane performance of an absolute return fund, he could be missing the opportunity to realise far better returns from being invested in a conventional fund.
Second, the fees attracted by absolute return funds are often not commensurate with the benefit for investors, particularly when performance fees come into play. The relatively low hurdle rates, especially when viewed over longer periods, give considerable scope for managers to earn excess fees, which is not in an investor’s best interests.
Makes you think, doesnt it?