As we enter September and markets continue to wobble, we may be entering another significant evolutionary period for the growth and appetite for absolute return investing.
The financial crisis of 2007 and 2008 will probably be viewed as a defining evolutionary stage in the history of the Absolute Return sector – in Darwinian terms the moment the sector grew legs. Prior to the extended period of volatility of the Northern Rock to post Lehman era, investors were rarely shaken out of the market en masse by seismic shifts in volatility.
Many stock market corrections over the decades prior to 2007 were followed sufficiently quickly by recoveries, or at least the prospect of a recovery, that investors were not left staring over a precipice wondering whether the aftershocks would actually be bigger than the first quake.
During the 2007/8 financial crisis, many investors’ long held belief that they would always be able to ride out a storm in stock markets and not be panicked into selling was challenged. Many exited the market close to the correction’s nadir as pain thresholds were broken and solutions to the global crisis were not evident.
Fear prevented many from participating in the subsequent rally. The bedrock of global markets – the financial institutions who were its intermediaries and principal participants – largely failed or needed support. What marked this crisis out from others was that the darkest hour before dawn just kept getting darker and the blood on the street went from streams to rivers in spate.
The appetite for absolute return strategies has grown since the crisis for two reasons: firstly, because they are mostly constructed with the goal of controlling volatility or risk at or below a fixed level, and secondly because they, by definition, are not tied to a benchmark.
While markets have recovered from the 2007/8 crisis, the medicine which has led to the recovery is still in trial phase nearly a decade on. Massive government intervention globally has been the cure for markets and institutions and as that is withdrawn, investors are not confident that the system is immune from a systemic crisis happening again.
Investor perception of the magnitude of potential shocks in markets has changed and the volatility controls that many absolute return strategies offer – which are designed to take investors out of markets when they become more volatile – are an attractive alternative to trying to ride out a storm again.
It seems a common definition for absolute return is finally being agreed after many years of confusion about what it really means: simply put, absolute return strategies are not measured against a benchmark – their goal is absolute rather than relative to a benchmark.
