The promise of absolute return strategies

Alex Johnson, BNP Paribas Asset Management

“Absolute return is not the type of product most investors wake up in the morning and say `that’s what I want,’” he told FSA during a recent visit to Hong Kong.

Rather, absolute return fixed income funds are usually recommended by a wealth manager or a consultant who has identified problems within the overall fixed income component of a client’s portfolio, which are usually duration and leverage, Johnson said.

Absolute return strategies in general are meant to be uncorrelated to fixed income funds, which explains why most of them do not have a benchmark index. “It is ultimately about shifting risk-adjusted returns in an overall portfolio,” he said.

Sharing the same sentiment, Nicolas Faller, co-CEO of asset management at Union Bancare Privée, said previously that investors may find absolute return strategies have lower correlation to fixed income products.

Return and volatility targets

Absolute return strategies are meant to behave a certain way regardless of current market conditions.

For example, absolute return funds, which could be just fixed income, equities or a mix of both, target a level of return usually stated as a few percentage above Libor, with a lower volatility than equity markets, according to Mehdi Douali, alternative strategies and multi-asset analyst at Allfunds.

However, on a short-term basis, the funds often show significant diversion from their targets for various reasons, such as mis-allocation in terms of duration in a bond portfolio, he said.

Despite their targets, absolute return funds have returned negatively on a three- and five-year annualised basis, according to FE data. Nevertheless, the volatility for these funds has been lower than the major bond and equity indices.

Annualised volatility and performance

Source: FE Analytics; Note: There are more MAS-registered absolute return funds compared to those registered with the SFC

Not well-defined 

BNPP AM’s Johnson noted that absolute return strategies can have sharp differences.

“We have not yet, in the industry, come across a settled vocabulary of what these things are,” he said, noting that asset managers should always be clear to their clients about the purpose and goals of their absolute return strategies.

For example, investors may think that an absolute return fixed income fund would have a long-short credit strategy, as many of them have become available in the market, Johnson said.

“But many of our clients would already have credit. If they have a global aggregate exposure, they would probably have a great deal of credit exposure within that index,” he said, adding that a long-short credit absolute return strategy is not a diversifier for those clients.

Johnson believes that his firm’s absolute return funds are differentiated because they target volatility rather than return.

It has two fixed income absolute return funds: the V350, which targets an annualised volatility of 350 basis points, and the V700, which targets an annualised volatility of 700 basis points. The goal of the funds is to provide uncorrelated returns and avoid huge drawdowns.

The three-year volatility of the V350 fund is 1.85, while the V700 fund’s volatility is 2.60, according to FE data.

Both funds invest in different fixed income classes, such as high yield, emerging markets, structured security and inflation-protected securities to make sure that they are diversified, he added.

The three-year performance of the V350 and V700 funds versus their sector.

Source: FE Analytics. Note: All fund and sector NAVs have been converted to US dollars for comparison purposes.