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Understanding Absolute Return Funds
The language and reporting around investments can be tricky, particularly if you’re just getting started and learning the lingo.
Regardless of how financially savvy you are, most of us understand that a graph showing an upward trend, tends to be good news. So, it’s natural enough that investors learning the ropes could be drawn to fund graphs with spikes and trends on the rise and shy away from anything in red that points downwards.
The thing is, not all funds are built with the same logic and it’s entirely possible to make money irrespective of the direction the market’s moving in.
Funds that offer investors this kind of opportunity are often called Target/Absolute Return Funds.
How are they different?
Target/Absolute Return Funds are different to more traditional Long Only Funds, as they’re known.
Long Only Funds rely on a Fund Manager buying and holding assets they believe will increase in value or deliver other positive returns over time through growth, dividend payments or interest payments.
The skill lies in picking the right securities.
The same is true for Target/Absolute Return Funds although the manner in which they try to generate returns is different. Rather than buying and holding assets in the hope that markets will rise - and this is the key difference - they also invest in less traditional assets and strategies that will look to benefit if markets fall.
As a result, the objective of these types of funds is to make a positive return regardless of the direction of markets.
Absolute Returns Investment Example
A Fund Manager believes the stock in Company XYZ is overvalued at a certain point in time and designs a plan to profit from a fall in value that they believe to be on the cards.
To do this, the Fund Manager borrows shares in Company XYZ from another investment provider for an agreed period, and sells them at the current price (a price they believe to be inflated), crediting the fund with the proceeds.
When it’s time to give the funds back, the Fund Manager buys the number of shares they owe – and here’s the important part - at the new (hopefully lower) price, on that day.
If the price has fallen, the fund makes money.
If it’s remained the same or risen, the fund loses money.
It’s a calculated risk.
The same strategy can be used across a range of assets and securities, allowing Fund Managers to employ what’s known as futures contracts, buying things like oil and Sterling and agreeing to sell it on at an agreed price and future date.
The hope being, they can buy the assets or currency at a lower price on the day they need to sell it, making a profit on the difference.
Of course, Fund Managers aren’t only looking for assets they expect will fall in value; they’re looking for positive returns too, with the aim of balancing the fund and achieving returns regardless of the overall market performance.