Negative correlation the real key to ar success

The IMA has had its fair share of flak over its latest sector review, but while the focus has been on when (and if) absolute returns are achieved, very little has been said about correlation.

Negative correlation the real key to ar success


As Esther Armstrong pointed out yesterday, the IMA has done the minimum it can to satisfy FSA concerns that absolute return products have the potential for systemic mis-selling, but it also acknowledged that the ideal would be to split the sector. Unfortunately, it says this is not possible at present because there are not enough funds to warrant different categories.

Fund picker’s are not always after promises of an absolute return over a certain period – they’ll be looking to do that from their asset allocation, not just from one or two funds within a portfolio. More of a priority is to find funds with a genuine long-term negative correlation to mainstream asset classes.

This might explain the popularity of the £14bn Standard Life GARS fund, its multi-strategy approach a world apart from the majority of the funds in the IMA sector, which follow a long/short equity approach.

“Within the GARS portfolio, we have no pre-determined aims for correlation with equities, or other asset classes,” says Andrew Ford, investment specialist of absolute returns at Standard Life Investments.

A dynamic approach

“We take a dynamic approach, increasing exposure to, and so correlation with, asset classes that we deem to be attractive at a given point in time. This ensures that the portfolio has exposure to asset classes that we believe offer compelling value on an on-going basis.”

According to Kepler Partners, which maintains the Absolute Hedge indices, there are around 330 Ucits absolute return funds. However, Georg Reutter, head of research, says that within each strategy – whether its long/short, global macro, credit, FX or others – there are “only a handful of really good funds”.

This may explain why some fund pickers actually avoid open-ended funds altogether when looking for absolute return-type strategies.

Ian Rees, head of research, multi-asset funds, at Premier, picks out CTA (commodity trading arbitrage), catastrophe reinsurance and distressed debt among his favourite lowly-correlated investments. These are all best accessed via London-listed investment trusts because of strict Ucits rules on liquidity.

Porting problems

Reutter explains: “Ucits broadly works for around 80% of hedge fund strategies and porting an existing offshore fund into Ucits is not simple.

“Liquid credit strategies are fine but anything distressed or event driven in credit is much harder to port into Ucits. Managed futures and anything with commodities in is also tricky. Other than that long/short equity, market neutral, and macro should be fine.”

The world of absolute return is a complicated and evolving area then, not easy for the IMA or even the AIC to categorise easily. Expect another review in a few months time!

A full run down of the challenges within the absolute return sector features in the March edition of Portfolio Adviser, out next week.



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