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In the latest Morningstar TV series Ask the Expert,analyst Anthony McDonald explains what investors should expect from an absolute return fund

Emma Wall:Hello and welcome to the Morningstar TV series, Ask the Expert. Im Emma Wall and here with me today to discuss absolute return funds is Anthony McDonald.

Wall:So, Anthony, what exactly is an absolute return fund?

McDonald:Well, it sounds straightforward, but an absolute return fund is a fund that seeks to make a positive absolute return for investors, so essentially to make money. The key point being that they should be making money regardless of the underlying market condition in the asset class, be it equities, be it bonds, that they primarily are investing in. So where they differ from your normal long-only equity or bond fund that most retail investors and advisors still use at the core of their portfolio is that they should be less dependent upon the direction of the underlying markets.

Wall:It sounds so simple, but why have so many funds in this sector failed to deliver that?

McDonald:Well, I think thats an interesting thesis to start with, because the sector has got a really bad reputation and there were a lot of high profile fund launches, especially in 2009-2010, which investors would say they were disappointed in. If we step back and we look at the IMA Targeted Absolute Return sector, which is as good a proxy as any for the sector, and I accept there is a degree of survivorship, but you could say over three or five years that most of the funds that are left there have actually delivered that positive return.

On the flip side, there are niches where most investors are disappointed. They havent necessarily delivered positive return as a sector through different market conditions. So over three years since 2010 to mid-2013, say, equities and bonds have delivered positive performance. So you would expect absolute return funds to have stayed in the game. What they havent managed to do is differentiate themselves during periods of difficult performance with the underlying markets. So if you look at periods such as mid-2011 when equity markets fell significantly or May/June 2013, where there was hiccup in bond markets and equity markets struggled to a degree as well, then you see the vast majority of funds or least the majority of funds in the sector struggled to make those positive returns.

You could argue that for investors who are seeking trying to find the uncorrelated outcome to underlying asset classes, thats the big disappointment. Because when the rest of their portfolio is not making money, they want and need the absolute return fund that is there for this purpose to still kind of grind out a positive return. So I wouldnt necessarily say the funds havent delivered in absolute return; its whether theyve got there in the way the investors need when theyre allocating to an alternative or a hedge fund or an absolute return fund, or whatever you want to call it.

Wall:This is Emma Wall for Morningstar TV. Thank you for watching.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a persons sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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