Investors spooked by the current turmoil in share markets are turning increasingly to absolute-return funds as a safe haven.

It's not hard to see why. These products, which have only become generally available in the past couple of years, aim to make money for investors in both rising and falling markets. So with shares plunging up and down like yo-yos, there is a strong temptation to seek out such products, which promise wealth preservation, rather than a rollercoaster ride.

Geoff Penrice, of Bates Investment Services, the independent financial adviser (IFA), says that the problem with conventional funds is that they usually struggle to make money in a falling market, but that is precisely what absolute-return funds aim to do. On top of this, he says, most funds justify their performance by comparing it with the sector they are investing in. But clients are more interested in absolute performance, not relative performance.

He says: “The sentiment of most investors is, ‘I would rather be in a below-average fund in a sector that is making money, than a top fund in a sector that is losing money'.”

Absolute-return funds achieve their steadier results through a combination of strategies. One is to invest in a wide range of assets, including not only shares, bonds and cash, but also the likes of property and hedge funds. It can also mean using derivatives, which are specialised products that allow investors to bet on the future price movement of an asset. Crucially, this allows investors to make money when an asset is falling, as well as rising, in price.

Used properly, these tools should allow absolute-return funds to do better than straightforward equity or bond funds when markets are falling, but the other side of the coin is that they are likely to lag behind their more conventional rivals when markets are rising.

One problem investors face is that the funds labelled “absolute return” use widely differing ranges of assets and investment tools. For example, the JPMorgan Cautious Total Return fund has a diverse range of assets, including shares, bonds and money market investments, whereas some funds, such as those from UBS and Baring, concentrate almost exclusively on bonds. Some, such as the BlackRock UK Absolute Alpha fund, use derivatives while others do not.

But do these funds actually do what it says on the tin? The past year has provided a perfect test of whether they can produce positive returns when markets are plunging, and some funds have proven to be better than others at weathering the storm.

At one end of the spectrum stands BlackRock UK Absolute Alpha. Over the past year, while the FTSE 100 index has fallen by 9 per cent, the Absolute Alpha fund has produced a positive return of 12.4 per cent. The Threadneedle Absolute Return Bond fund, meanwhile, has performed even better with a return of 12.7 per cent. Not far behind comes JPMorgan Cautious Total Return, the diversified portfolio of which has produced a positive return of 6.3 per cent.

At the other end of the spectrum are absolute-return bond funds from groups such as Credit Suisse and UBS. The Credit Suisse fund has lost 16.1 per cent over 12 months, while the UBS fund has lost 18.2 per cent.

Why have these two done so badly when the Threadneedle fund - another bond fund - has performed so well? Justine Fearns, of AWD Chase de Vere, another IFA, says: “The Threadneedle fund has the ability to go short on bonds, whereas the other two do not. When the credit crunch struck, the Credit Suisse and UBS funds went down, while the Threadneedle fund went up, so it would appear to have put to good use its ability to go short on bonds.”

Mr Penrice adds: “Absolute-return funds have a place in many investors' portfolios because they aim to do what a lot of investors want, which is to make money and preserve wealth, in good times and in bad. However, it is vital that investors choose carefully because a number of the so-called absolute-return funds have not done what it says on the tin and have actually lost investors money over the past 12 months.”

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