Absolute return that does what it says on the can

Over the past few years, absolute-return funds (hedge-fund-style products for private investors) have been touted as a solution. However, many of these have disappointed by failing to protect investors' money against market falls (read more on this). But there are always exceptions, and a particularly notable one is SWIP UK Flexible Strategy (GB00B1265J60). This fund has delivered a positive return in each of the past four calendar years since current manager James Clunie has been running it, as well as roundly beating its benchmark, three-month Libor.

These also stack up to strong cumulative returns, with the fund beating its benchmark and Morningstar category, 'Alt - Long/Short Equity - UK', over one and three years. This is in line with its investment objective of a positive capital return over the long term regardless of market conditions.

"Generally, absolute-return funds underperform in a rapidly rising market and far too many have also failed to protect on the downside, suffering significant declines," says Andy Parsons, head of investment research at The Share Centre. "However, the SWIP UK Flexible Strategy Fund has consistently performed over the past three years. The fund aims to generate long-term returns through a combination of both long and short positions in UK equities. In 2011, the fund and investment approach truly came to the fore, demonstrating the ability to deliver a positive return against tough economic and market conditions. The fund delivered a positive return of 3.4 per cent compared with a negative return of -15.75 per cent for its Investment Management Association (IMA) sector (Specialist)."

Short selling is a technique used by hedge funds whereby rather than investing in a security in the hope that its price will rise, you effectively take a bet on its share price falling.

"For those investors seeking an investment opportunity that allows the manager true flexibility in his investment decisions with the ability to short a company where concerns arise over valuations and business risks, this fund may well be suitable," adds Mr Parsons.

The fund initially identifies potential short positions via SWIP's fundamental research process, which estimates a fair value for a stock. From this position, SWIP's stock lending data screens identify the risks and catalysts. The manager then looks to short the stocks he believes are overpriced, and where there is a catalyst and limited short selling.

SWIP UK Flexible Strategy has a reasonable total expense ratio (TER) of 1.69 per cent for a fund of this kind and does not levy a performance fee. This is in contrast to some hedge-fund-style products which charge in excess of 2 per cent.

However, SWIP UK Flexible Strategy may lag in rising markets, while the manager's ability to take short positions adds another layer of risk and complexity, as he might not get his 'bets' right causing a loss for the fund. But Mr Clunie is very experienced and has proved himself over difficult times, so if you have a well-diversified portfolio and want to try to limit the downside, this fund is a buy.

Source: Morningstar, *Scottish Widows Investment Partnership (SWIP)

Source: Morningstar as at 22 March

Top 10 holdings

Source: SWIP

Net position (%)