As many institutional investors have significant exposures to equity and fixed income markets, absolute return strategies which achieve these goals can play an important role in an institutional investor’s portfolio.
Bunglawala says: “Absolute return funds give institutional investors access to strategies with a lower correlation to traditional markets that also deliver returns.”
The purpose of an absolute return fund in an institutional investor’s portfolio has changed. Keith says: “In the past, these funds were used to outperform the markets but there is now much more of a focus on using them to provide some counterbalance when markets turn.”
But, given the current market conditions, for absolute return managers to be able to meet this targets will require a specific skill set. Bunglawala says: “Managers will need to be able to deliver a range of alternative sources of return; which are not only dependent on calling macro views correct.”
These alternative sources of return could be, for example, momentum strategies or convexity.
Bunglawala says: “These managers should also be blending both fundamental and quantitative techniques as well as mitigating market risk by using macro hedging strategies.”
As well as selecting the funds with these characteristics, institutional investors should also select funds with low market beta and low correlation to traditional asset classes.
Finding those funds which are able to satisfy the strict criteria demanded by institutional investors may require looking at a broader universe of funds than they have done in the past.
A smaller fund might well be better able to source returns from a range of alternative sources. Cadbury says: “Smaller absolute return funds can select from a much broader range of assets than a larger fund.” This, along with a smaller fund manager’s ability to be more nimble, retain its maverick identity translates into a better ability to generate returns than a larger manager.
Cadbury says: “We compared the performance of small to large managers all the way back to 1997 and discovered that those smaller managers consistently outperformed their larger rivals.”
Not only did smaller firms tend to outperform larger firms over this time period but the performance particularly held up during times of market distress. As many investors feel nervous about the current punchy equity and bond market valuations, selecting a smaller absolute return manager might make particular sense given the current market conditions, says Cadbury. Despite the advantages of selecting a smaller rather than a large fund, many of these funds are simply ignored by institutionals, says Cadbury. “For too many investors, the process of selecting the right funds has become a box-ticking exercise.” But for those investors who are prepared to go and find the smaller, lesser known managers can be well rewarded, he adds.
For larger institutional managers, however, there is a significant downside to selecting a small asset manager – they will need more than one manager to spread their assets evenly.
Cadbury says: “But investors need, at least, to be willing to listen to a wide range of ideas so they can get a true picture of the options available.”
Absolute return funds could help institutional investors to weather the tough market conditions that lie ahead. But they will need to be prepared to look at a broader universe of products if they want to find the right fund.
