An investment that's not for faint-hearted

Last month, a growing band of economists cut their forecasts for UK growth in 2011.

Weakness in the housing market and recent survey data convinced BNP Paribas to reduce their forecast from one per cent to just 0.6 per cent even though the Office for Budget Responsibility is expecting 2.3 per cent growth.

Japanese-owned Daiwa Capital Markets say a double-dip recession remains a good chance and have cut their expectation of growth here by 0.3 per cent to 1.6 per cent.

There is a form of finance which aims to achieve positive returns regardless of the economic climate – the absolute return fund (ARF). This is a hedge fund and so its investment strategy may look quite contrary to conventional collectives.

Unlike traditional active funds where the managers select shares expected to rise, ARF managers take advantage of falling prices.

They achieve this by 'shorting' (effectively betting that prices will drop) and then buy the same firms when their share prices start to rise again.

Such a process naturally involves volatility and so is not for the faint-hearted.

However, ARFs can make sense to hold for a proportion of a balanced portfolio. It is also only fair to judge their performance over several years.

In a difficult market, there are five star absolute return retail funds, according to research by Lipper for the Yorkshire Post, showing their growth in the last three years:

CF Ruffer Total Return, up 46.7 per cent;

Newton Real Return A, up 26.5 per cent;

CF Whitefoord Absolute Return, up 26.2 per cent;

Threadneedle Absolute Return Bond, up 21.1 per cent;

GLG Total Return Bond, up 16 per cent.

The minimum investment is 1,000 for each except Threadneedle's which is 2,000. For tax efficiency, the first three can be kept in an Individual Savings Account (ISA).

Capital Financial Managers are clearly on a roll as investment managers, having two of the top three funds. The Newton fund in second place is managed by BNY Mellon, which enjoys an international reputation.

All except Threadneedle have initial fees but these can be reduced if using a discount broker like Torquil Clark. Typical charges are five per cent initially and 1.5-1.75 per cent annually.

Funds in this sector sometimes additionally offer their managers a performance carrot based on returns above the previous highest price, known as a 'high watermark.' Of course, after two to three years of economic difficulties, the targets should be set high enough to encourage outstanding management.

Whilst such extra charges are a factor to consider as they drag performance, the latter is a good incentive for outstanding stock picking.

ARFs should be considered for long-term savings, ideally 10 years, as they do not rely solely on the performance of the stock market.

They run several strategies simultaneously to capture opportunities and both spread and limit risk.

As an example, the Close Global Trojan is a fund of funds with 58.6 per cent invested in financial services and the balance in industrial materials. Based in Jersey, its major holdings are in the Cayman Islands (51 per cent), UK (29.2 per cent) and Canada (11.6 per cent). This fund has attracted over 12.3m and accepts individual sums from 10,000.

There are disappointing ARFs and so it is necessary to monitor performance. SVM UK Absolute Alpha and Liontrust European Absolute Return are two of the most lacklustre and savers should consider switching to one of the better performers.

The leading ARF in the last three years – CF Ruffer Total Return – has its top four holdings in Vodafone, BT, Gold Bullion Securities and telephone manufacturer Ericsson.

It believes that "the corporate wallet will continue to open, whether in the direction of mergers and acquisitions or reviving capital spending, and it is a factor that will most likely keep the double dip at bay."

With few backing Japan, this fund takes the contrary view and has 15 per cent invested there. It notes that there is a policy shift to currency intervention.

Another group form the investment company hedge funds with 6.6bn under management.

Over one year they are up four per cent and over three years have outperformed the investment company average by 12 per cent.

The leaders over three years according to the AIC using Morningstar research are:

BlueCrest AllBlue US$, up 98.3 per cent;

BH Macro euro, up 93.8 per cent;

Third Point Offshore US$, up 45.6 per cent;

Dexion Absolute US$, up 31.5 per cent.

Several such groups have funds in differently denominated currencies which can produce alternative figures, such as Dexion Absolute three year growth of 13.9 per cent (euro), 2.3 per cent (sterling) but 31.5 per cent (US dollars) and so discuss the most appropriate route with your broker or independent financial adviser.

Jonathan Baker of Leeds stockbrokers likes Gartmore European, which is up over seven per cent since launch in January 2009. This is one of four ARFs run by Gartmore worth 693m in total. Its top holdings include Vodafone, Deutsche Lufthansa, ABB and Tesco.

Gartmore UK Absolute Return, run by Ben Wallace, is also tipped by Baker.

This fund is invested one-third in core ideas for long-term growth aiming at 20 per cent annually and the balance is tactical opportunities.

ARFs usually have "well diversified underlying portfolios and therefore can generally offer a reduced risk route into equity markets", says Martin Payne, Leeds director at brokers Brewin Dolphin.

He tips both Cazenove Absolute Target Fund, which was launched in July 2008 and focuses on UK mid to large cap stocks, and Standard Life's Global Absolute Return Strategies.

The latter has a 1.5 per annual management charge but no performance fee.

ARFs differ on their benchmarks, risk profiles and timeframes for delivering performance.

Investments are sometimes restricted to UK equities whilst others are widened to continental Europe and some global. Generally those with a wide mandate and multi-asset class can perform better.