With absolute return strategies failing to deliver on their promise of “strong returns with low risk” many asset owners are rethinking their value.
The problem is they have disappointed on both a relative and absolute basis when it comes to aggregate returns during a ten-year period of passive equity gains, low risk-free rates, and declining credit spreads.
Diversification away from equity and credit has largely led to underperformance during this time. Coupled with the potential for higher fees and tracking error, investors have been re-thinking absolute return allocations.
But according to Travis Schoenleber, a managing director at Cambridge Associates, absolute return still warrants an allocation in asset owners’ portfolios although investors need to be more selective about how they invest.
Ahead of Investment Magazine’s Absolute Return conference held in Sydney on September 17, he says: “Prior to the GFC, investors could invest in an “average” absolute return strategy and obtain a decent return outcome. Today, the landscape has shifted as markets are more efficient with more strategies offering less alpha.
Investors need to be more critical about stress-testing these strategies, understand the differentiation/edge, and be aware of underlying asset liquidity in stressed periods, he goes onto say. Some absolute bond strategies, as an example, have shown themselves to be less defensive and less liquid than advertised.
“An absolute return portfolio allocation needs to be diversified. Multi-strategy offerings remain viable, multi-asset remains a strategy for those desiring less equity exposure, and global macro still has a role to play despite underperformance in the recent environment. More interesting opportunities have arrived via sector focused long-short managers and credit managers providing capital in lieu of traditional bank lending.”
The holy grail of absolute return investing is achieving high returns that are uncorrelated with equity markets. But as Schoenleber sees it, that reality, in aggregate, has not proven out over the last decade. In response, many asset owners now “split the bucket” by adding risk a higher risk component as well as a more defensive enhanced alpha piece.
So, are investors looking for alpha or risk mitigation?
In Schoenleber’s view they’re on the hunt for both. But investors are attempting to be smarter about their approach and so are trying to enhance performance with one half and get better protection with the other.
“Investors are looking across the whole spectrum of what fits within the absolute returns space –- you’re looking at wider range of strategies like alternative liquid alts, risk premia, credit, and direct-lending strategies.
“Allocations are becoming more targeted with some as more return seeking and some more focused on hedging and enhanced alpha. This has allowed investors to better target exposures, fees, and risk levels, with an ultimate goal of enhancing returns.”
In an environment of low bond yields and expensive equity valuations, the evolution of absolute returns will continue with only the future proving whether this evolution is more successful over the next decade.
