A current key investment theme is how to achieve low-volatility returns from equities when the option of using bonds looks risky if central banks turn off the money taps.

One of the investment themes of the past 12 months has been
how people can capture bond-like steady returns but at a time when the 30-year
bull market in fixed income is widely hailed as over.

A quality that fixed income investors – especially those in high-grade
sectors – look for is low volatility. So with bond markets looking vulnerable
if the US Federal Reserve really does decide to turn off the money-printing
machine (as it will have to do eventually), what options are there in equities?

One idea is to hold an “absolute return” fund that takes
long and short positions in such a way as to neutralise the biases and quirks
of particular sectors and geographies, but also capture some if not all of the
returns available in a consistent way. This sort of approach will typically
mean the investor has to pay a bit more in fees than for a purely long-only
fund, but the peace-of-mind factor might be worth it.

Step forward Julius Baer Absolute Return Europe Equity fund,
overseen by Andy Kastner, of
Zurich-headquartered Swiss & Global Asset Management. His fund, which was
launched on 30 September 2010, has around €240 million of client money.
The fund is structured as a UCITS 4 vehicle. The fund has a 0.6 per cent
management fee for institutions, 1.2 per cent for private clients, and there is
a 10 per cent performance fee with a high watermark.

What is specific about this portfolio is that it is a
long/short equity fund designed, by its pairings of long and short positions on
stocks in the same sector, to be market-neutral as a whole and neutral on
sectors as well.

Low volatility

"This is a low-volatility fund, at about 3.5 per
cent," Kastner told this publication in a recent interview. So far, the
fund has since launch, made returns of around 14 per cent and has been up in
all the calendar years of its existence. It is up between 3 per cent and 4 per
cent this year so far, he said.

That return has been racked up while the fund has had volatility
of a respectably low 3.1 per cent, compared to return of 16.7 per cent for the
Euro Stoxx 50 with volatility of 22.5 per cent, according to data from Swiss
& Global AM.

The range of clients for the fund is large, with the likes
of pension schemes, private banks, and discretionary wealth managers.
"There is not a particular type of client we are focusing on," he
said. Client money comes from Germany,
Italy, Switzerland, the UK
and Spain.

"This is a good fund for risk-averse investors who are
looking for a low-volatility fund but who do not want interest rate
risks," he said, arguing that his fund has a low correlation over time to
other asset classes.

Perhaps significantly, Kastner said that there is increasing
interest in the fund from long-only bond investors, suggesting that equities
can fill a need so long as they are addressed in the right way.

So how does it work?

Kastner explains that the portfolio has anywhere around 30
to 40 long/short stock pairs at any one time; this means that for every firm of
a certain type (such as energy, or healthcare or tech) where the fund has a
long, or bullish stance, it holds a similar firm in the same category but where
the fund has a short, or bearish stance.

For example, Kastner is long Aryzta (Swiss bakery firm),
short Nestle (looking overpriced, recently missed some growth targets); he is long
Iliad, short Orange
(the telcos); and he is long Svenska Cellulosa (good prospects for its tissues
and toiletries business, not much analyst coverage, etc), and short Unilever
(unattractive valuations).

Kastner says he holds such pair positions for around 8-12
months.

With a UCITS 4 fund, the requirement that holders can gain
same-day liquidity – so they can withdraw money quickly if requested – means the
underlying portfolio must be similarly liquid, so how can the fund do this with
long/short pairs with a holding period of up to a year?

Kastner says that equity positions are taken via total
return swaps; this ensures ample liquidity in the fund. Via the swaps, liquidity
is invested in money markets to ensure funds are available at short notice if
need be.

With all such investments, of course, the usual verity about
not assuming that future returns are guaranteed by past performance applies. There
may be rough weather ahead. So far, at least, however, this fund seems to have
delivered the kind of journey that bond investors would like to have.