26/05/2008
Absolute return funds for retail investors?
Many advisors may have watched the rash of product innovation in the investment industry with some bemusement, wondering what, if any relevance some of the new products have for them and their clients. In addition to mis-selling scandals and tightening regulation, volatile markets may have left some unwilling or uninterested in unfamiliar or seemingly untried investment strategies. However, I think multi-asset absolute return funds could be very relevant indeed for retail investors, especially for defined contribution pensions and additional voluntary contribution investors.
The holy grail of all pension savings is to preserve members’ lifestyles after retirement while minimising the impact that saving has upon their current standard of living. The pressures and expense of everyday life, from housing to raising and educating children, often prevent DC savers from making substantial contributions during their early working lives. However, later in life they may have more disposable income available to save. As a result, it is usually only during these latter years that pension funds are likely to become large and therefore it is at this time a growth-based investment strategy is particularly valuable in the quest to preserve lifestyle in retirement and minimise required contributions. Unfortunately it is often at this time that many savers adopt a more conservative investment stance in fear that more risky investments will have too little time to bear fruit before retirement.
This is where retail savers and investors can benefit from advances in investment management made on behalf of defined benefit schemes. Their goal has been to find high levels of stable but significant returns and it is being achieved by adopting a truly diversified approach. This is often based on setting absolute return targets for their managers rather than traditional relative-performance benchmark approach.
Effective absolute return strategies rest upon robust and repeatable investment processes, combining dynamic allocations to traditional asset classes, with more advanced sources of market returns often obtained using derivatives. The manager moves dynamically between asset classes, selecting only those they believe likely to generate the best return over a given period. Successful implementation of such a strategy involves freeing proven managers to implement their best ideas to the full extent of their conviction.
One way these funds can move between asset classes is to employ carefully constructed derivative positions, which help to avoid the high costs and taxes of dealing in conventional assets. Derivatives also allow the absolute return fund manager to access the relative outperformance of proven asset class managers, even in asset classes that are falling, providing an additional source of returns.
The key to producing reliable returns through actively choosing asset classes is to take a relatively long term approach. Individual markets follow trends that may persist from two to five years or beyond. This market inefficiency can be successfully exploited by allowing your investment manager to simultaneously employ a wide variety of ideas that are likely to benefit from these trends. This means that at any given time some of these long term ideas will be are paying off to give stable positive performance.
Most traditional investment approaches only take short term views of markets and stocks as they seek to beat traditional benchmarks over short time periods. As a result of there being so many active managers operating in this way it is much harder to reliably generate additional returns. Exploiting longer term views is, by comparison, relatively reliable provided the manager has sufficient scope to implement a wide range of ideas.
Complex as this may sound, the result is straightforward, positive long-term returns with low levels of volatility. It is this stability, coupled with the current trend towards flexible retirement, that enables DC pension savers to consider investing their pension funds to seek maximum reward, even when relatively close to retirement. This gives the possibility of a significantly enhanced lifestyle in retirement and before.
These absolute return strategies have become available now as a result of significant demand, which makes it economically feasible to build the infrastructure necessary to deliver them successfully. Demand was previously subdued as the use of derivatives had made investors cautious. Now there is increased understanding that there are different types of derivatives and that many are straightforward, liquid and transparent. This has allayed the traditional aversion to derivative use. In addition most conventional funds now regularly use derivatives for efficient portfolio management anyway.
Ultimately, absolute return investing could represent an excellent option for pension savings.
Chris Nichols, Investment Director, Strategic Solutions, Standard Life Investments
This was published in Investment Adviser on 26th May 2008.
Standard Life Investments Limited, tel. +44 131 225 2345, a company registered in Scotland (SC 123321) Registered Office 1 George Street Edinburgh EH2 2LL.
The Standard Life Investments group includes Standard Life Investments (Mutual Funds) Limited, SLTM Limited, Standard Life Investments (Corporate Funds) Limited and SL Capital Partners LLP. Standard Life Investments Limited acts as Investment Manager for Standard Life Assurance Limited and Standard Life Pension Funds Limited.
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©2008 Standard Life Investments.
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