Master market uncertainty in 2025 with absolute return investing
Amid significant market volatility, Portfolio Managers Luke Newman and Ben Wallace explore how absolute return investing and strategic diversification can safeguard and enhance investor portfolios.
Key takeaways:
- Absolute return strategies offer the flexibility to navigate through economic uncertainties by taking both long and short positions, thereby potentially insulating portfolios from drastic market fluctuations and enhancing performance.
- Such strategies not only provide a safety net against market volatility but also offer a strategic advantage which can capitalise on short-term market opportunities.
- This approach not only helps in smoothing the return profile over time but can also significantly enhance the overall return potential, thus offering a dual benefit of stability and growth in an investor’s portfolio.
Absolute return investing: A type of investment strategy that seeks to generate a positive return over time, regardless of market conditions or the direction of financial markets, typically with a low level of volatility.
Correlation: How far the price movements of two variables (eg. equity or fund returns) move in relation to each other. A correlation of +1.0 means that both variables have a strong association in the direction they move. If they have a correlation of -1.0, they move in opposite directions. A figure near zero suggests a weak or non-existent relationship between the two variables.
Factor/style investing: This investment strategy seeks to identify and target unique characteristics that represent defined sources of risk or return, that can potentially drive long-term returns. In simpler terms, this could mean a particular size (ie. large vs small cap), a particular style (growth vs value), quality, or market beta.
Liquid alternatives: Liquid alternatives can be easily accessed eg. in a mutual funds and exchange-traded funds (ETFs) structure, with daily pricing and liquidity. They offer the diversification benefits of alternative assets, and the investment capabilities of alternative strategies.
Long position: A security that is bought with the intention of holding over a long period, in the expectation that it will rise in value.
Market beta: A measure of the relationship that a portfolio or security has with the overall market. The beta of a market is always 1. A portfolio with a beta of 1 means that if the market rises 10%, so should the portfolio. A portfolio with a beta more than 1 means it will likely move more than the market average (ie. more volatility). A beta less than 1 means that a security is theoretically less volatile than the market.
Cycle: Investment markets tend to go through cycles in popularity and performance, fluctuating between expansion and contraction, reflecting a range of input factors, such as the economic or geopolitical backdrop, relevant legislation, technology, industry or consumer demands.
Net and gross exposure: The measure of a portfolio’s exposure to the market. Net exposure is a combination of both long and short positions. It is calculated by subtracting the amount of short exposure as a percentage of a portfolio, from the amount of long exposure. For example, if a portfolio is 100% long and 20% short, net exposure is 80%. Gross exposure is calculated by combining the total value of both long and short positions, as a percentage of a portfolio. For example, if a portfolio is 100% long and 20% short, gross exposure is 120%.
Short position (shorting): Fund managers use this technique to borrow then sell what they believe are overvalued assets, with the intention of buying them back for less when the price falls. The position profits if the security falls in value. Within UCITS funds, derivatives – such as CFDs – can be used to simulate a short position.
Tactical book: A portion of an investment portfolio that be used to make quick adjustments to a portfolio, allocated to short-term or situational investment opportunities. This can be used to try and preserve capital, potentially improve risk-adjusted returns, and to take advantage of an identified short-term factor.
Volatility: The rate and extent at which the price of a portfolio, security or index, moves up and down. If the price swings up and down with large movements, it has high volatility. If the price moves more slowly and to a lesser extent, it has lower volatility. The higher the volatility the higher the risk of the investment.
Luke Newman: We’ve seen a highly volatile start to the year in both equity and fixed income markets, with huge disruption driven by uncertainty around the path of tariffs and the future direction of the global economy. This is exactly the environment that we feel causes our investors to examine their own portfolios and look for potential alternatives that could provide insulation in terms of performance, but also from a risk perspective. And we feel that areas such as liquid alternatives and absolute return funds can fulfil this need.
Ben Wallace: One of the key attributes of absolute return funds is that they’ve got all the tools in their box to make money independent of market direction. They’ve obviously got the ability to take both long positions and short positions in shares, and also flex both the net and the gross of the portfolio. This means you can exploit both upside and downside and also volatile markets to the benefit of the end investor.
Newman: Portfolio diversification can provide real value to investors in multiple ways. Having assets with low beta and correlation characteristics to not only equity markets, but also to asset classes such as fixed income and currency markets, can provide reassurance that your investment objectives can be achieved.
Wallace: In addition, quite often a tactical book will have the ability to exploit those shorter-term opportunities in the market, and if ultimately successful, this tactical book can both ‘smooth’ the return profile of a fund, but ultimately also boost the return profile of the fund.
Newman: One of the benefits of absolute return is the ability to deliver differentiated drivers of performance within investors’ portfolios. This is obvious relative to the swings in capital markets such as fixed income and equity markets. But also, when you look at the cycles in style and factor biases, particularly when they arrive, violently and in a sudden fashion, as we’ve seen over the course of this year, can provide real value, once the inclusion of absolute return is factored into portfolios.
These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. References made to individual securities do not constitute a recommendation to buy, sell or hold any security, investment strategy or market sector, and should not be assumed to be profitable. Janus Henderson Investors, its affiliated advisor, or its employees, may have a position in the securities mentioned.
Past performance does not predict future returns. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.
The information in this article does not qualify as an investment recommendation.
There is no guarantee that past trends will continue, or forecasts will be realised.
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Key takeaways:
- Absolute return strategies offer the flexibility to navigate through economic uncertainties by taking both long and short positions, thereby potentially insulating portfolios from drastic market fluctuations and enhancing performance.
- Such strategies not only provide a safety net against market volatility but also offer a strategic advantage which can capitalise on short-term market opportunities.
- This approach not only helps in smoothing the return profile over time but can also significantly enhance the overall return potential, thus offering a dual benefit of stability and growth in an investor’s portfolio.