The dictionary definition of absolute returns is “a fund which aims to deliver positive returns in all market conditions, with low volatility”. An emphasis on capital preservation is generally understood to be a core part of the proposition.

Before 2008, most assets sat in traditional middle of the road balanced funds with a smaller fixed interest component and a larger equity exposure. Since then, in a low interest world, fund managers have sought to diversify by offering a broader and more evenly spread mix of asset classes, including alternatives and taken a more unconstrained and active approach to asset allocation. The idea of a ‘cash + x%’ followed, thus giving investors the expectation of a return.

In Ireland there are about 12 absolute returns funds available from Insurers. Recent performance has not been good with average 3-year performance to February 2019 slightly negative.

Why the poor returns? Charges are one factor, tending to be higher than balanced funds. We estimate the extra charge averages 0.35% bringing the total management charge to 1.35%. It is expensive but an extra charge is appropriate for the more resource-intensive management the funds demand, and in reality, investors would be very happy to pay it if the objectives were being achieved.

2018 was a bad year for all investments and absolute returns were no exception. The volatility of the funds over the past 3 years has averaged 5% compared to global equities of 40%. This suggests the fund managers are just not taking enough risk with their portfolios, particularly those funds promising returns of Cash + 4% or 5%. The problem seems not to be a bad 2018 but a failure to benefit from strong growth in 2016 and 2017.

The real problem is the return expectation is set too high. It is not possible to achieve the level of return promised with the current level of downside protection. Absolute returns funds are suitable as a substitute for lower risk assets but do not expect them to deliver at the higher level of promised returns.