Sponsored Q&A: Absolute returns

Ashley Shaw is head of distribution for the Macro Currency Group.
Shaw is responsible for leading the Group's development on a global basis. He joined the firm in 2008. Shaw received an MSc in International Business & Finance from the UMIST School of Management and has a BA (Hons) in History from the University of Manchester.

1. What are the key questions institutional investors are asking about absolute return funds and how would you answer them?

ASHLEY SHAW: Once the traditional growth driver of choice for pension funds, it is safe to say that, for most institutional investors, equity returns have disappointed over the past decade. While manager selection may have identified benchmark-beating performance, when the reference point for these managers have only posted small returns these efforts are akin to picking up pennies in front of the funding deficit steam roller.

And so investors are - rightly - once again turning to absolute return strategies as a means of injecting much needed growth into their pension schemes in a bid to improve funding ratios and smooth the path to recovery. But with this new approach (which isn't particularly new, truth be told) investors are faced with a different vernacular, forced to move away from the (cold) comfort of ‘benchmark relative' investing (a false construct anyway) and must begin asking new questions: How will this strategy impact my portfolio over the next one, five and ten years? Will it help improve my funding level, reduce portfolio volatility or both? How does it interact with the rest of my portfolio? How transparent is the approach and do I understand how the manager will achieve the stated objective?

At the Macro Currency Group we run a top-down global macro approach that combines strategic and tactical themes into a portfolio of best ideas. Having run the same investment process since 1997 using only highly liquid and transparent instruments, the team has generated a positive return stream that is uncorrelated with most other asset classes - which should help improve funding levels whilst reducing overall portfolio risk.

2. What factors should pension schemes bear in mind when trying to choose the absolute return fund best suited to their needs?

ASHLEY SHAW: Moving away from a pre-defined universe, as absolute return investing necessitates, managers are granted the opportunity to implement their views, often on a cross asset class basis or utilising specialist asset classes, with more freedom than in traditional approaches. Rather than assessing a manager's ability to beat a benchmark (no easy task in itself), pension funds looking to adopt an absolute return strategy within their portfolio should ascertain why the manager in question has chosen their specific tool box for the task/job.

With this opening question, institutional investors will begin understanding not only the investment process but also the manager. Insights into a manager's background, their experience, their intentions, as well as view formation, should be forthcoming, as should a greater awareness of how the strategy will be implemented, what, when and how various instruments will be utilised, but also which environments might see the strategy underperform?

This last point is an important one as while absolute return strategies are designed to deliver throughout the market cycle and regardless of market environment, few strategies deliver returns in a straight line - understanding when and why a strategy might underperform will go some way to mitigating future anxieties.

3. How easy is it to differentiate between different absolute return approaches?

ASHLEY SHAW: Although, initially, it may appear daunting, differentiating between absolute return strategies shouldn't be any more difficult than it is differentiating between managers in the traditional/benchmark relative world. In general terms, ignoring the performance objective is a good start (the investment objective is roughly the same, only the nomenclature differs).

A logical starting point is to focus on how returns are generated - be it by asset class (equity, fixed income, multi-asset, other), approach (individual manager, multi-manager) or investment style (discretionary, systematic, in-house, external managers). After even the most cursory assessment, adopting this approach will provide a straight-forward framework for differentiation upon which further research efforts can be conducted.

For me, the second layer of research would then focus on the return outcome - this is looking further than ‘did the manager achieve their stated return objective' (itself a good differentiator) and assessing the return profile of the strategy or how performance was delivered.

This might include: correlation analysis (looking at the degree of correlation a set of returns has with major asset classes or the rest of your portfolio - the lower or more negative the correlation, the better the diversification benefit), information ratio/Sharpe ratio assessment (both measures of how efficiently the manager is using their risk budget to generate returns), drawdown analysis (examining the magnitude of a strategy's negative performance periods, including the ‘depth' and ‘length' of these periods) and a liquidity analysis (how liquid is the strategy and what do compensation I receive if I am reducing my liquidity terms?).

In this way, institutional investors can begin to quickly and easily differentiate between a variety of manager styles and approaches to absolute return investing.

4. What approach do you believe the IMA should take to the classification of absolute return funds?

ASHLEY SHAW: As at the end of February 2012 the IMA Absolute Return sector contained 75 funds with a range of investment universes and approaches: Asian Bonds to Currency through to US equities, managed by individual managers or via of fund-of-funds approach, etc.

Now that the sector is firmly front and centre in the collective investment mind, the IMA might draw inspiration from the hedge fund world and begin introducing subcategories - whether these are defined by investment style, approach or asset class, the IMA sector is now big enough to benefit from such an approach.