Fund performance is often measured on a three-year time horizon. And, over that short period, many absolute-return funds may seem to offer the steady cumulative returns that investors crave. The most attractive will offer small consistent annual returns which seem to build wealth without the gaudy gains that might serve as a warning that too much risk is being taken. Looked at on a three-year view, an attractive absolute-return fund might show ‘small return, small return, small return’. But as the financial crisis demonstrated, there can be a ‘Taleb distribution’ of returns ie ‘small return, small return, small return, catastrophic loss’. Under this scenario, the fund manager appears to be very smart (small gain, small gain, small gain) until they’re shown not to be so smart (large loss) after all. And while losses are always unwelcome, they need not necessarily come as a surprise if the underlying strategy – the way in which a fund seeks to deliver an absolute return – is understood.
This may sound like a rather negative view of absolute-return investing. It isn’t. At SWIP, we firmly believe that absolute-return strategies have an important role to play; their embrace by a wider constituency of investors following UCITS III is to be welcomed. In fact, I manage a similar strategy myself. But while it was launched as an absolute-return fund it is now more properly labelled the SWIP UK Flexible Strategy Fund.
Investors learned a lot of lessons in 2011. To take just two examples, the eurozone is far more fragile than previously thought and America could lose its AAA credit rating without triggering a meltdown in the global financial system. For investors in absolute-return funds, meanwhile, 2011 brought another important lesson – always look beyond the label.
James Clunie is manager of the SWIP UK Flexible Strategy Fund.