The great divide: why absolute return should be split in two

There is a great divide in the absolute return sector between fundamental long-only funds and complex hedge fund-like strategies, and the latter could give the rest a bad name.

That is according to Freddie Lait, founder and CIO at UK fund boutique Latitude Investment Management, who told Citywire Selector that it would be in the best interest of investors if the sector was split.

‘The problem with the absolute return sector is I see there being a huge difference between the fundamental absolute return funds and the far more quantitative ones that invest in very small issues of bonds or over the counter derivatives.’

The absolute return fund manager said investors would benefit from increased clarity about what they are investing into. In order to do so, the sector first needs to mature in terms of its understanding.

Performance split

The key distinction in the absolute return sector between the fundamentals and the more quantitative funds is that when you split them up you can see that the performance has fallen into those two categories, he said.

It largely comes down to the investment philosophy as the more ‘straight-forward’ funds in the sector invest long-only in bonds, currencies, gold and stocks with a focus on capital preservation and return in equal measure.

‘They are very different products and some of the others are far more complex. They are chasing their own tails in terms of the hedging, there's a lot of embedded risks that are not necessarily visible.

'Funds like Jupiter, which takes very large short positions, they don't run a lot of risk on paper but being short the market is an extraordinary risk.’

Hidden risk

The use of derivatives, options and shorting in the more complex structures tends to be very expensive shorter term, he added, as investors can lower risk by using the instruments but they tend to spend premium to do so.

‘If we generate 2-3% from our more tactical cash and bonds positions, the compounding power of that compared to the more complex products in the market is enormous.’

Lait, who runs the Latitude Horizon fund, which is a long-only absolute-return fund, said he is not surprised to see fundamental strategies raising assets this year despite the sector losing money rapidly.

‘We're seeing some of the larger ones that are the more complex hedge fund-like sort of structures haemorrhaging assets. It does give the overall sector a slightly bad name but the individual businesses and boutiques who defend that sensible long-only methodology will continue to strive and thrive.’

At the next stage of the cycle, thinking about risk differently will become increasingly important, he said. Liquidity risk is one piece of that but complexity and a lack of transparency and accessibility also fall into it. 

Over one year to the end of June, the Latitude Horizon GBP Inc fund returned 3.3% in euro terms. This compares to the average manager in the Mixed Assets - Flexible EUR sector's return of -0.3% over the same timeframe.