Absolute return funds

What is “Absolute Return”?
The objective of Absolute Return funds is to achieve a positive return regardless of the market conditions. These funds do not follow any reference index, rather they seek to obtain high returns that are consistent with their level of risk, placing emphasis on preservation of the capital. Moreover, they are not usually related to traditional investments, meaning they offer significant diversification to investment portfolios.
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How do they do it?

With a lot of flexibility: both in the assets in which they invest (fixed-income, equities, currencies, etc.), and in their investment policies and management styles: these funds can be used both for increases (by taking buying positions known as "longs") and decreases (by taking selling or "short" positions) in the value of an asset. Moreover, they intensively use different financial instruments (derivatives, mostly) to manage their risks and to enable them to adapt appropriately to different market environments.

Are there different types of Absolute Return funds?

There are different ways to categorize absolute return funds, according to the type of asset they invest in (equities, fixed-income, currencies or multi-asset), their management style (relative value or opportunistic), the extent of their exposure to the market (market neutral or directional) or their level of risk (this is the categorization we like the most here at BBVA QF). It is also very common to see Absolute Return funds classified according to the type of alternative management strategy they follow (“equity market neutral”, “long/short equity”, “CTA”, multi-strategy of fixed-income and currencies, global macro, etc.).

This wide variety among Absolute Return funds makes them highly heterogeneous and, therefore, their returns vary extensively.
However, what is really important when assessing an Absolute Return fund is its ability to obtain attractive returns that are consistent with its level of risk, its capacity to protect the capital and the diversifying power it offers.

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What are the main investment strategies of Absolute Return funds?

Absolute Return funds follow various alternative investment strategies, which provide different levels of exposure to the market. The most common strategies include:

  • Equity Market Neutral: investment in equities (stocks or derivatives), adopting buyer (long) positions and seller (short) positions, achieving a market-neutral effect, seeking the return through the net differential of both investments (taking their specific risk), regardless of the direction of the market (thus avoiding market risk).
  • Multi-strategy of fixed-income and currencies: flexible and dynamic investment in sovereign debt, corporate fixed-income securities and/or currencies, seeking to profit from undervaluations and overvaluations of these assets. -“CTA (commodity trading advisor)”: systematic investment in different assets, adopting buyer (long) positions and seller (short) positions, using sophisticated algorithmic models that are able to analyze a large amount of information in order to select those that offer higher probabilities of revaluation based on their trends.
  • Long Short Equity: dynamic investment in equities (stocks or derivatives), adopting both long and short positions, as above, but in an opportunistic manner, trying to take advantage of the direction of the market, both up and down, being able to achieve returns in both bull (rising) and bear (falling) market scenarios. The big difference compared to the “Equity market neutral” strategy is the extent of its exposure to the market, which is usually much higher in this case (its net exposure is higher than 20% or lower than -20%).

To be taken into account:

  • It is important not to confuse investment in Absolute Return funds with Hedge Funds (which are free-investment funds). Absolute Return funds are regulated by the European UCITS (the "Undertakings for Collective Investment in Transferable Securities Directive”), a unified regulatory framework with requirements for the protection of the investor, and they are liquid funds, unlike hedge funds which offer worse liquidity conditions and are not regulated by this standard.
  • Manager risk: in these types of funds, the management team becomes of pivotal importance, since the success of the fund depends directly on how capable the team is and on its ability to adapt to different market conditions. In many cases, they are “author funds”, the future of which is intimately linked to that of the manager.
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