Absolute Return Funds and Liquid Alternatives: What They Promise and What They Deliver

The 2008 financial crisis demonstrated that traditional portfolios — even well-diversified ones — could suffer severe losses because most "diversifying" assets were correlated with equities when it mattered most. This shock accelerated demand for genuinely uncorrelated returns: strategies that could make money (or at least lose very little) while traditional portfolios were falling. Absolute return funds and liquid alternatives emerged as the retail-accessible answer to this demand. The record over 15+ years is instructive — sometimes impressive, sometimes disappointing, and frequently misunderstood.

What "Absolute Return" Means

An absolute return mandate targets a positive return in all market conditions — typically expressed as a target above cash (e.g., "SONIA plus 3–4% per year") rather than relative to a benchmark index. The goal is to provide positive returns regardless of whether equities rise or fall, bonds rally or sell off, or credit spreads widen or tighten.

This contrasts with a traditional equity fund (whose mandate is to beat the FTSE All-Share or MSCI World) or a bond fund (whose mandate is to outperform the gilt index). An equity fund manager who loses 15% while the index falls 20% has met their mandate. An absolute return fund manager who loses 5% in the same period has failed theirs.

The promise and the problem. True market-neutrality is very difficult to achieve. Most absolute return funds carry some positive market exposure — they tend to perform somewhat well in rising markets and somewhat poorly in falling markets, rather than being genuinely uncorrelated. The degree of residual market exposure varies enormously across strategies and managers.

Main Liquid Alternative Strategies

UCITS Long/Short Equity. The most common liquid alternative structure. The manager holds a portfolio of long positions (stocks expected to rise) and short positions (stocks expected to fall). By adjusting net exposure (longs minus shorts), the manager can target market-neutral (zero net) or long-biased (30–60% net long) positioning. UCITS rules limit leverage to allow short exposure only through derivatives, capping the scope of leverage relative to offshore hedge funds.

Global Macro (UCITS). Top-down macro strategies express views on interest rates, currencies, commodities, and equity indices using liquid derivatives. Man GLG, Winton, and BlueTrend manage UCITS versions of their flagship strategies. Global macro UCITS funds can be genuinely uncorrelated — Winton's trend-following strategy, for example, was up substantially in 2022 when most traditional asset classes fell sharply.

Multi-Strategy Absolute Return. Combines several strategies within a single fund — event-driven, statistical arbitrage, macro, volatility trading — to diversify across return sources. Standard Life GARS (Global Absolute Return Strategies), once the largest absolute return fund in Europe at over £25 billion, ran a multi-strategy approach. Following a period of underperformance (2016–2018), substantial redemptions reduced its size dramatically — a reminder that multi-strategy funds can underperform for extended periods when their diversifying assumptions break down.

Systematic/Quantitative. Rule-based, model-driven strategies that identify and exploit patterns across asset classes. Managed futures / trend-following (CTA) strategies are a subset. AQR's UCITS funds, Man AHL, and Winton all offer systematic strategies with daily liquidity. These strategies tend to perform best in sustained trending markets (up or down) and struggle in range-bound, choppy conditions.

Volatility Arbitrage. Strategies exploiting the difference between implied volatility (what options cost) and realised volatility (how much the market actually moves). These strategies tend to generate steady income with occasional sharp losses when volatility spikes (as in February 2018 and March 2020).

The Performance Record: An Honest Assessment

The UK IA Targeted Absolute Return sector (the IMA category that captures most UK-domiciled absolute return funds) has a mixed record:

Average returns. Over the decade from 2013 to 2023, the average IA Targeted Absolute Return fund delivered approximately 1–2% annualised in total return. Cash (3-month T-bills or SONIA) delivered approximately 1.8% over the same period. Many absolute return funds did not beat cash over a decade — a damning assessment of the category average.

Dispersion is high. The category average masks huge variation. The top-performing absolute return funds (well-implemented macro and CTA strategies) delivered 3–6% annualised. The bottom performers lost money. Selecting the right strategy matters enormously more in absolute return than in long-only equities.

Best conditions for absolute return. Absolute return strategies tend to add most value in:

• Bear markets and market stress (2022 was exceptional for managed futures/CTA)
• Periods of high cross-asset volatility (macro strategies benefit from large moves)
• Environments with multiple independent return sources (mergers, regulatory changes, rate moves)

Worst conditions. The period 2016–2021 — low volatility, grinding bull market, flat yield curve — was very difficult for most absolute return strategies. Few trends to exploit, few dislocations to arbitrage, and steady equity markets that outperformed everything alternative.

Crisis Alpha: The Key Claim

The most important claim for absolute return strategies is crisis alpha — the ability to generate positive returns when traditional portfolios are falling sharply. This is the primary reason to include them in a diversified portfolio: not for their average return, but for what they do when it matters most.

The evidence for crisis alpha is selective but real:

• 2008: Managed futures CTA strategies were strongly positive — the Barclay CTA Index returned approximately +14% — while global equities fell 40%+
• 2022: Trend-following strategies returned 20–40% while global equities fell 18% and bonds fell 15% — the first major year in decades where traditional 60/40 diversification failed completely
• 2020 March crash: CTA performance was mixed — the crash was too fast for trend-following to capture; macro strategies with positioned views on rates performed well

The qualification. Crisis alpha is not consistent. Managed futures strategies needed sustained trends (2008 was 12+ months of persistent decline; 2022 was persistent inflation-driven moves). The March 2020 crash resolved within a month — too fast for systematic strategies to exploit.

Sizing and Portfolio Role

Absolute return strategies are best understood as portfolio diversifiers, not return generators. The appropriate sizing for most multi-asset portfolios is 5–15% — enough to matter in a severe market dislocation, not so much that mediocre average returns drag the portfolio significantly during bull markets.

The fee question. Many absolute return UCITS funds charge 1.0–1.5% per year in ongoing charges, with some charging performance fees of 10–20% of gains above a hurdle. At these fee levels, a strategy targeting SONIA plus 3–4% needs to deliver gross returns of 5–6% to net 3–4% for investors. This is achievable for top-quartile managers but the category average does not clear this bar.

ETF alternatives. A growing number of trend-following and macro ETFs provide rule-based systematic exposure at lower cost:

• iM Global Partner US Equity Risk Managed UCITS ETF
• Invesco Balanced-Risk Allocation UCITS ETF
• WisdomTree Managed Futures UCITS ETF

These systematic lower-cost alternatives may be more appropriate than expensive multi-strategy absolute return funds for many investors.

Due Diligence for Absolute Return Funds

When evaluating an absolute return fund, the key questions are:

1. What is the strategy specifically? A vague "multi-asset, targets positive returns" description is insufficient. Ask for the underlying strategy components and their typical positions.
2. What happened in 2022? A fund that claims to protect against equity downturns should have evidence from 2022 specifically — the most severe drawdown in traditional 60/40 portfolios in decades.
3. What happened in 2020 March? A fast, sharp crash — was the fund down with equities or not?
4. What is the fee structure including performance fees? Calculate total expected cost at a median return scenario.
5. What is the Sharpe ratio and Sortino ratio across a full market cycle? Look at 7+ year records that include both bull and bear periods.
6. Is this strategy capacity-constrained? Statistical arbitrage strategies often degrade as assets under management grow — managers that have scaled heavily may have lower future returns than their historical track record suggests.

Compliance Notes

Absolute return funds do not guarantee a positive return in any period. The term "absolute return" describes the mandate, not the outcome. Past performance in stressed market conditions (2008, 2022) does not guarantee similar performance in future market dislocations. Many absolute return funds underperform cash over extended periods. Fees in this category are typically higher than passive equity or bond funds; the performance hurdle is correspondingly higher. This guide is for information purposes only and does not constitute financial advice.

How Global Investments Can Help

We assess absolute return and liquid alternative strategies as part of our alternatives allocation process, focusing on genuine evidence of crisis alpha rather than category labels. For investors seeking diversification beyond traditional equity and bond exposure, we can identify strategies with credible evidence of uncorrelated returns. Contact us to discuss the alternatives component of your portfolio.