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What is an absolute-return fund, strategy or system?

Understanding Absolute-Return Systems

An absolute-return system is a sophisticated financial strategy aimed at generating positive returns, regardless of prevailing market conditions. This approach stands in contrast to relative return strategies that focus on outperforming a specific benchmark or index. Absolute return strategies are particularly appealing to discerning investors due to their potential for true strategic diversification, extending beyond the traditional confines of market sector diversification.

Contrasts with Traditional Investment Approaches

The absolute-return system diverges from the classic ‘buy and hold’ investment approach. It employs a diverse arsenal of investment techniques, including short selling, futures, options, contracts for difference (CFDs), bonds, and arbitrage. These varied techniques are designed to capitalise on opportunities in both rising and falling markets, marking a proactive departure from more passive investment strategies.

Comprehensive Breakdown of Investment Techniques
  • Short Selling: This strategy involves selling borrowed securities with the intention of buying them back at a lower price, aiming to profit from the difference.
  • Futures: Futures contracts are agreements to buy or sell a particular asset at a predetermined future date and price, allowing investors to speculate on or hedge against future price movements.
  • Options: These contracts offer the right, but not the obligation, to buy (via call options) or sell (via put options) an underlying asset at a specified price before a set expiration date.
  • Contracts for Difference (CFDs): CFDs are agreements that allow traders to speculate on the rising or falling prices of fast-moving global financial markets or instruments without actually owning the underlying asset.
  • Bonds: Bonds are debt securities, whereby the investor loans money to an entity (corporate or governmental) that borrows the funds for a defined period at a fixed interest rate.
  • Arbitrage: This involves exploiting the price differences of identical or similar financial instruments on different markets or in different forms.

Despite their potential for consistent performance, these strategies are not without risks, particularly when involving complex derivatives and leveraged positions.

Examples of Absolute-Return Strategy Practitioners

Notable firms such as Bridgewater Associates and Man Group have effectively utilised absolute return strategies. Bridgewater’s Pure Alpha fund, created by Ray Dalio, is designed to achieve positive returns in various market conditions. Similarly, Man Group’s AHL division leverages systematic trading models across different asset classes to pursue positive returns irrespective of market trends.

While the success stories of these firms highlight the effectiveness of absolute return strategies, potential investors must approach with a clear understanding of the strategies’ complexities and associated risks. While capable of producing positive returns in diverse market conditions, these strategies can also lead to substantial losses if not managed carefully.

Conclusion

The absolute-return system, with its goal of generating consistent positive returns independent of market trends, offers a unique approach to investment. It provides an opportunity for portfolio diversification but necessitates a comprehensive understanding of the risks involved. Prospective investors are advised to thoroughly assess these risks before investing.

“Most people are too fretful, they worry too much. Success means being very patient, but aggressive when it’s time.” – Charlie Munger

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