The evolution and future of absolute return

The sharp corrections and increased volatility of stock markets this August will have hurt many investors. For Absolute Return managers it should have provided an opportunity to demonstrate their skill in managing risk and protecting investors’ capital.

The evolution and future of absolute return

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After the pain that benchmarks caused for many investors in the crisis, the appeal of owning an asset because you believe there is a higher probability of it making money than not is, understandably, greater than owning an asset because the benchmark owns it and therefore you probably should. If the benchmark corrects sharply with markets, why be tied to it again?

These are the principles of absolute return and it is easy to see why, given the events of the last decade and the fear of contagion in the future from larger institutions and more connected global markets, it has become more attractive and many new participants have entered the market. However, managing these strategies requires complex skills in portfolio construction and risk management.

Many of the managers are new and their ability to fulfill their investment remit has yet to be tested in the conditions where they are designed to operate – a nasty crisis. Despite traditional investment approaches being hit by periods of heightened volatility over recent years, markets have been relatively kind to absolute return strategies and pitfalls have yet to be uncovered. Since so many were established after the last crisis as a solution for the next crisis, there is understandable scepticism that a crisis vaccine has been found!

Not everyone exited the market in the great financial crisis either. Investors are not a homogeneous crowd who operate in unison on a binary ‘in or out’ basis and many really can take the long view and ride out the volatility storm.

Absolute return is not for everyone therefore, but the shift in performance measurement from relative to absolute return has become a far more established practice. Many investors want to measure the performance of their investments by whether they made money or didn’t rather than whether they made or lost more or less money than a benchmark which, for many, might have been a rather nebulous yardstick.

This demand for change in performance measurement will be difficult to reverse and the longevity of absolute return will largely depend on the investment management community’s ability to deliver real absolute returns in all market conditions.

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