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Research report

Absolute return for an uncertain world

History shows us that absolute return strategies have historically delivered on many of the goals of traditional fixed income—and have successfully navigated the challenges markets currently face.

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July 13, 2021 | 10 minute read

We wrote last year about the challenges facing core fixed income and the need for a reexamination of the traditional “40” side of a portfolio. With the potential for interest rates to rise further, increasing correlation between stocks and bonds, and inflation concerns permeating markets, we believe the challenges investors face are far from over. Yet while there appears to be consensus around the problem, choosing a fixed income alternative has been particularly vexing. Given their goal of generating positive returns regardless of market environment with low correlation to traditional investments and moderate volatility, we believe absolute return funds are a compelling option to replace or complement what has become a very challenged “40.”

Absolute return investments aim to deliver positive, uncorrelated returns with low volatility, regardless of broader market performance. Unlike many traditional funds which are designed to access certain asset classes or employ certain investment strategies, absolute return funds are designed to achieve specific outcomes. Their performance is evaluated on a standalone—or absolute—basis against this stated objective. Given this outcome orientation, the construction of absolute return funds can and often does vary. These investments are unconstrained, meaning they can invest across many different asset classes, use derivatives and invest both long and short. While they may look different, little broad market correlation and low volatility are key tenets across absolute return strategies. Absolute return funds’ ability to invest outside the realm of traditional asset classes (i.e., beyond stocks and bonds) allows them to generate truly differentiated returns while their ability to invest both long and short offers the potential to not just mitigate downside risk, but to profit from declining markets as well.

Key takeaways

  • The traditional “40” has struggled lately as interest rates have risen, and it faces further challenges going forward.
  • We believe we have entered a new regime in which stocks and bonds will remain positively correlated, diminishing the diversifying power of fixed income.
  • Absolute return funds exhibit many characteristics traditionally sought in core fixed income and, we believe, are an attractive bond alternative.
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This information is educational in nature and does not constitute a financial promotion, investment advice or an inducement or incitement to participate in any product, offering or investment. FS Investments is not adopting, making a recommendation for or endorsing any investment strategy or particular security. All views, opinions and positions expressed herein are that of the author and do not necessarily reflect the views, opinions or positions of FS Investments. All opinions are subject to change without notice, and you should always obtain current information and perform due diligence before participating in any investment. FS Investments does not provide legal or tax advice and the information herein should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact any investment result. FS Investments cannot guarantee that the information herein is accurate, complete, or timely. FS Investments makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information.

Any projections, forecasts and estimates contained herein are based upon certain assumptions that the author considers reasonable. Projections are necessarily speculative in nature, and it can be expected that some or all of the assumptions underlying the projections will not materialize or will vary significantly from actual results. The inclusion of projections herein should not be regarded as a representation or guarantee regarding the reliability, accuracy or completeness of the information contained herein, and neither FS Investments nor the author are under any obligation to update or keep current such information.

All investing is subject to risk, including the possible loss of the money you invest.

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Kara O’Halloran, CFA

Director, Investment Research
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