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Absolute choices

In these uncertain times, choosing which funds to invest in is tricky. The explosion of absolute return funds and the attraction of these “safer, lower-volatility” investment vehicles is clear to many investors. However, with vast differences between the funds on offer and the IMA deciding not to review the sector for at least another year, what guidance do investors have that they are indeed the safe, low-risk investment option that they are touted to be?

Over the 12 months to August, the dispersion of return in the IMA absolute return sector alone was over 50 per cent, from minus 20 per cent to plus 30 per cent. Not much guidance there then.

With market participants agreeing on one thing at least, that volatility is likely to rise, we can expect the demand for this type of fund to increase. The sector has grown to include 43 funds and around £13bn in assets under manage-ment at the end of August. The rise of the Ucits III vehicle has underwritten this development in new-style product offerings and the pace is unlikely to slow any time soon. However, what investors must accept is that Ucits III is just a frame-work within which asset managers can operate, it is not a skill set in itself and finding underlying managers and strategies that can meet investors’ expectations in a robust, repeatable and risk-controlled manner will remain key.

Despite often being marketed as defensive investment vehicles, absolute return funds are exposed to market fluctuations and it is their use of deriv-ative instruments which empowers the strategies they employ.

The main challenge is how to choose between the strategies on offer, which requires a significant amount of research and due diligence. The focus should be on identifying the strategy of the fund manager, that is, the underlying asset class and its liquidity and transparency.

Pricing is often a contentious issue and these funds can come with performance fees, often charged at 20 per cent if the fund outperforms a certain hurdle rate, with a high watermark. The principle of paying for success is one thing but is the price appropriate to the risk undertaken and the risk control demonstrated?

Aidan Kearney is co-head multi-manager funds at Aberdeen Asset Management

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