Absolute vs Relative Return

Absolute vs Relative Return

Postby LenaHuat » Thu Sep 04, 2008 6:05 pm

Business Times - 04 Sep 2008


Meeting challenges confronting investors

THESE are difficult times for investors, when market volatility - while relatively tamer on a monthly basis - has ratcheted up from its lowest point in early 2007. The coast is far from clear. Forecasts of a market recovery are almost uniformly pushed back as the credit crunch eats into the real economy. It is at times like these that investors who have stayed the course nurse their wounds and those who have retreated to the sidelines in cash emerge looking good.

Among fund managers, in particular those who are proscribed by their mandates to only buy and hold shares, the temptation to use cash as a market timing and asset preservation tool is strongest. Merrill Lynch's monthly global fund manager survey found that the average cash weighting of global managers was nearly 5 per cent in July. While that may sound modest, bearing in mind that many mandates require fund managers to be almost fully invested, as many as 53 per cent reported they were overweight cash.

It is typically in bear markets that debate on the merits of relative and absolute return funds is revived. While in a bull market, investors are happy to measure their returns against a benchmark, in a bear market, beating the benchmark is cold comfort; what investors hanker after is a positive return at a minimum. Absolute return funds, however, entail a vastly different set of risks and expectations compared with relative return vehicles.

Long-only managers with an absolute return mandate would seem to wield an edge in the ability to use cash tactically. But while cash may boost short term performance rankings in a poor market, it raises the risk that managers may be caught wrongfooted in their re-entry into markets, particularly if the market recovery is sharp and sudden.

This was what happened in the midst of the Asian crisis when managers sought shelter in cash. In the sharp recovery in 1998, some funds lagged the index by more than 50 per cent.

Ultimately, managers should not stray too far from their mandates. Long-only managers' cash weightings are typically capped at modest levels mainly to provide liquidity for investors, who on their part would do well to ponder their asset allocations. After all, the choice of absolute or relative return funds should not be a mutually exclusive one. Absolute return funds, with their cash-plus risk and return profile, are likely to underperform in a bull market. Yet they could be a stabiliser in bear markets like today's.

As for relative return funds, managers increasingly have a range of derivative instruments at their disposal. Options, for example, lend some measure of protection or yield enhancement. There is also a new generation of exchange-traded funds, including short-only funds. Thus, while today's investment climate is indeed challenging, investors can take some comfort from the fact that professional managers have the benefit of an expanded toolkit of financial instruments.


This is a very unusual BT editorial. I need to move away from my laptop now and so will comment on this at a later time.
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Re: Absolute v Relative Return Funds

Postby LenaHuat » Thu Sep 04, 2008 11:47 pm

On 2 Sep, BT wrote an editorial that sounded like a stark pointed warning for a domestic audience : "Wall Street is still irrationally exuberant". Worthy of particular mention is the last paragraph of the editorial :

Contrarians keen to buy when everyone else is selling should therefore take note: US investors are still irrationally exuberant and stocks could therefore be primed for much more volatility ahead.

The domestic audience is now larger than b4 as the readership of BT has risen considerably. I wonder if it has generated its intended effect and caused local unit trust holders to file in their redeemptions on that day. These orders would have gotten to the HQ by 3 Sep and thereby caused 2day's rout. If this conjecture is right, then it will contradict MM's point that 2days' sales are falling into weak hands. It could be either be (a) weak hands to weaker hands :?: (b) weak hands (fr mandated sales) to strong hands (instituitional investors) :?: :?: Looking at the volumes and the index breakers (KepC, CDL, Wilmar), IMHO (a) is unlikely. If the index breakers are the banks, it could be altogether different.

Now, back to 2day's editorial, which is no less unusual than 2 Sept's editorial.
Long-only managers with an absolute return mandate would seem to wield an edge in the ability to use cash tactically. But while cash may boost short term performance rankings in a poor market, it raises the risk that managers may be caught wrongfooted in their re-entry into markets, particularly if the market recovery is sharp and sudden.

This was what happened in the midst of the Asian crisis when managers sought shelter in cash. In the sharp recovery in 1998, some funds lagged the index by more than 50 per cent.

Let me recap this from ST 30 June 2008 so that forumers can get an idea abt the spectacular V-shaped 1998 recovery.
To recap: In 1998, STI had lost a staggering 33 per cent in the first half, only to recover by an even more spectacular 38 per cent for the rest of the year, as a credit crunch then gripping Asian economies subsided.

In 1997/1998, US hedge funds had a field day rocking Asia ex-Japan markets. The IMF, then cash-flushed with US$$ rode to Seoul, Bangkok, KL and Jakarta like white knights but wielding sticks, spears and clubs. The rest is history. Subsequently, these US vultures picked up Asian equities at rock bottom prices.

Forward to Sep 2008, the US economy is in serious difficulties. Japan is now a recessionary nation of good soldiers but no leaders. The strong hands are those who have large reserves and are now shopping for soccer clubs, Hollywood studios or the mysterious stealth players like the Chinese and Russian SWFs. These strong investors are relatively new to the game compared to the Americans and Europeans. Would these investors generate the V-shaped recovery :?: IMHO, I don't think so but I would like to be wrong :lol:
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Re: Absolute v Relative Return Funds

Postby LenaHuat » Thu Sep 04, 2008 11:55 pm

Part 2 comments, akan datang 2morrow.
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Re: Absolute v Relative Return Funds

Postby la papillion » Fri Sep 05, 2008 12:05 am

Awaiting your 2nd part :P Enjoying every bit of it, haha
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Re: Absolute v Relative Return Funds

Postby millionairemind » Fri Sep 05, 2008 8:26 am

Like a young boy waiting for a candy, I eagerly awaits Lena's post...:D

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Re: Absolute v Relative Return Funds

Postby LenaHuat » Fri Sep 05, 2008 10:10 am

Yo, LaP and MM, both of U unnecessarily flatter me. Juz penning some lazy tots when the market is so fearful. :lol: :lol: Writing burns up cerebral fuel, now gonna refuel with brunch. Maybe 2nite then.
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Re: Absolute v Relative Return Funds

Postby OE2008 » Fri Sep 05, 2008 10:42 am

LH, Thought provoking. Looking forward to part 2 8-)
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Re: Absolute v Relative Return Funds

Postby kennynah » Fri Sep 05, 2008 12:48 pm

maybe out tonight...but that's not stopping me from turning on the wifi...just to read this thread ... good one L...
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Re: Absolute v Relative Return Funds

Postby LenaHuat » Fri Sep 05, 2008 11:49 pm

2nite, I'll give some food for thought based on the Chinese proverb that "A crisis is also an opportunity". This proverbial statement often sound cliche as no big big investor has really opened up its books and put a finger of numbers on it. Let me extract this from the Norwegian Ministry of Finance's disclosure on their Pension Fund (Global), which actually is their Petroleum Fund.

One method for illustrating the risk associated with the Government Pension Fund is to select certain historical events, and to calculate, on the basis of these, the return on the Fund under what can be characterised as crisis scenarios. Events that form an apposite basis for such calculations are, inter alia , the crisis in the 1930s, the stock market crash in 1987, the Asian crisis in 1997, and the technology bubble in the late 1990s. Below is a presentation of such calculations performed for both the Government Pension Fund – Global and the Government Pension Fund – Norway.

There have been several periods over the last century characterised by very large fluctuations in the international the securities markets. Table 1.3 and 1.4 shows the estimated change in the value of the Fund under its current asset composition and country allocation for seven different crisis scenarios. The first column of Table 1.3 (labelled ”Year 1”) shows e.g. that the value of the Fund would have declined by about 3 pct. in the first year in the crisis in the period 1929-33. The Fund would have been reduced by 8 pct. in the second year, and by a further 19 pct. in the third year. Consequently, the aggregate loss over these years is estimated at 30 pct. of the value of the Fund, when compared to the value at the beginning of 1929. However, the return over the following two years would have more than compensated for the loss in the first three years. The value of the Fund would have increased by close to 17 pct. in the fourth year after the crash, and by almost 21 pct. in the fifth year. Corresponding analysis has been carried out for the other six periods of crisis.

The results indicate that the value of the Fund over time seems reasonably robust as far as the type of crisis that occurred during the 20th century is concerned. Last century was, at the same time, characterised by very positive developments in the international securities markets. One cannot rule out the possibility that the future may bring new periods of crisis where the losses are not recouped as swiftly during subsequent periods as has been the case over the last century.

Table 1.3 Change in the value of the Government Pension Fund – Global for five successive years as the result of a crisis, given the current equity and bond composition and regional allocations. The Funds currency basket. Per cent
***************************Year 1 ****Year 2 ***Year 3 ***Year 4*** Year 5
The 1930s (1929-1933) **********-3.3 ****-8.2 ****-19.0 ****16.7 *****20.7
The oil crisis (1973-1975) *********-8.6 ***-14.1 *****36.6
The stock market crash (1987) *****-0.2
Mexico (1994) ******************-4.5
The Asian crisis (1997) ************22.2
The Russian crisis (1998) **********17.1
The technology bubble (1999-2003) **16.4 ***1.2 ******-6.0 ****-8.2 *****16.9

The interesting bit abt the above is : If a crisis originates from the US or impacts the US gravely (with the exception of the 1987 stock market crisis), the light at the end of tunnel is some 3-5 years away :cry:

Can small investors, like most of us here, stomach the volatility and outlive it?? This brings me back to the BT editorial's 1 liner that I fully agree with :
The coast is far from clear. Forecasts of a market recovery are almost uniformly pushed back as the credit crunch eats into the real economy. It is at times like these that investors who have stayed the course nurse their wounds and those who have retreated to the sidelines in cash emerge looking good.


This crisis is only an opportunity if one has the cash to deploy when the market recovers.
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Re: Absolute v Relative Return Funds

Postby la papillion » Fri Sep 05, 2008 11:52 pm

Hi lena, I like your piece by piece picking of the article :) More?
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