Absolute Return sector "not fit for purpose"

Many of the sector’s funds consistently fail to live up to their aim of delivering a return greater than zero and there is little else to connect them with one another.

By Mark Smith, Reporter, FE Trustnet
Friday May 18, 2012

The Absolute Return sector is too complex and wide-reaching for its constituent funds to be accurately compared, FE Analytics data shows.

Unlike other IMA sectors, Absolute Return funds are defined by what they aim to deliver rather than what they invest in. Simply put, these funds aim to achieve a return greater than zero in all market conditions. However, as any seasoned investor knows, funds in every sector frequently fail to live up to their promises.

According to data from FE Analytics, 44 of the 71 funds in the sector, or 62 per cent, have failed to deliver an absolute return over the last 12 months, with the average fund showing a loss of 1.64 per cent. Over three years, six funds have lost money, with the worst-performing – SVM UK Absolute Alpha – posting a loss of 23.06 per cent.

Only 44 per cent of funds have given investors a real return versus inflation over the last three years.

The positive return proposition has made the sector increasingly popular as macroeconomic risks continue to weigh on traditional equity investments. Over the last year nearly £5bn has flowed into it.

The main problem is that cautious investors who need products capable of maintaining their capital buy the funds on the promise of slow and steady returns and end up taking on more risk than is appropriate.

Industry commentators have long called for an overhaul of the sector.

"The Absolute Return sector is just poor," said Darius McDermott, managing director at Chelsea Financial Services.

"We have been saying for ages that it should be split on lines of volatility. Some of the funds in the sector are essentially high risk hedge funds. The funds we tend to recommend from it tend to be more straightforward market-neutral strategies."

CF Octopus Absolute UK Equity is a good example of the type of strategy that McDermott looks to avoid.

Managed by David Crawford, the fund’s stated objective is to deliver a positive return in all market cycles by investing in derivatives that provide both long and short equity positions.

Over the last three years it has been more volatile than any other fund in the sector and only one fund has returned less. Its annualised volatility score of 14.19 per cent is more in line with that of the average UK Smaller Companies or Global fund.

Performance of fund vs benchmark over 3-yrs

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Source: FE Analytics

The FSA is currently undertaking work to assess the extent of the risk posed by the sector's funds.

"Financial advisers may not fully understand these products, which increases the possibility that poor communication of investment risks contributes to mis-selling to consumers," the regulator warned in its latest Retail Risk Conduct Outlook.

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philip john hadley Jul 11th, 2012 at 10:08 AM

like other funds absolute funds do not always do what it says on the tin buyers beware.

John Clark May 21st, 2012 at 05:30 AM

The "Absolute Return" sector - like the "smoothed returns" of With-Profits policies - sells punters the alluring story of good returns with minimal risk. And like their discredited forebears, these funds are often opaque and have high charges.

Avoid.

Orlando Furioso May 19th, 2012 at 07:43 PM

As usual the FSA tilts at advisers with its comment implying their mis-selling by 'poor communication of investment risks'. I would have thought it's pretty obvious from the graph of the Octopus fund that anyone selling it up to 30 months ago saw it as a good risk (as it had performed very well up to that point and appeared to be doing what the Absolute Return Sector said on the tin). After that it was then the Octopus fund manager who subsequently failed to understand how to continue to generate returns with his investment strategy, and Octopus itself that did nothing about it. They continued to promote and sell it as if nothing had happened. I know as I was there at one of their presentations and had to ask what had happened, otherwise they would not have referred to it. So now, gone on, FSA, have a go at Octopus for this negligently misleading behaviour. Or wouldn't it fit with your model of 'the IFA is always wrong and, anyway, fund management companies have too much money to pay good lawyers to tangle with'?

jonuk76 May 18th, 2012 at 02:24 PM

I think the whole "absolute return" sector is highly misleading. None of these funds have any guarantee of an absolute return over any time period. In the case of funds like SVM Absolute Alpha you'd have been better off taking a wad of cash and flushing it down the toilet than investing there.

As a serious suggestion, perhaps the sector should be called something like "Alternative Investment Strategies" and sub divided into categories (Equity Long/Short, Global Macro, Market Neutral etc) with any mention of "absolute returns" banned. This would better describe what they are - and probably scare off the more cautious retail investors who likely shouldn't be in these funds anyway.

I can see why the industry has been keen to launch them as they carry hefty management fees, and the aim of "absolute returns in any market conditions" play into investor fears, but it's time something was done about it.

AJP May 18th, 2012 at 02:05 PM

This is no worse than the All Companies Sector and the performance of some companies within that.

Theo May 18th, 2012 at 01:46 PM

This fund has investments of £50.7 mln. Who on Earth are the IFAs who put people into these funds?

northerngooner May 18th, 2012 at 01:08 PM

It is absolutely crazy (no pun intended) - how can you cram all these types of funds into one sector when the aims and objectives of many of these funds are so wildly differing ???
The phrase round peg in square hole comes to mind.
Specialist Sector is another useless piece of kit.

Tiny Clanger May 19th, 2012 at 02:06 PM

Well you're not wrong there mate. I hold JPM Natural Resources, Invesco Perpetual Latin America, Investec Global Gold, Axa Framlington Biotechnology and First State Indian Subcontinent in my Portfolio. What correlation do any of these funds have to one another? They are all in the "Specialist" sector so use the same benchmark. It's a joke. You could say, tentatively, that JPM and Investec have investments in gold so could possibly be correlated but the rest of them bear no relationship to the price of gold. As there are only two funds in the "Biotech" sector anyway, (mine and Franklin Templeton), why are they in there at all? As far as I am concerned, all funds should be benchmarked to something like the Footsie 100 so that there is no hiding place for Managers. Then when you say, "They've outperformed the Index", everybody can see that they really are "Alpha managers".

jonuk76 May 19th, 2012 at 07:22 PM

Just a small correction here. While Trustnet may use the IMA Specialist sector index as a benchmark for basing their analytic scores on, I expect they would readily admit that this is not ideal.

The sector really just serves as a classification for funds that don't fall anywhere else, like single sector or single country funds. It's not appropriate to use the IMA Specialist index as a benchmark.

The fund managers themselves would use other benchmarks, e.g. JPM Natural Resources uses HSBC Gold, Mining & Energy Index as a benchmark. The AXA Biotech fund uses the NASDAQ Biotech index. You'd have to read the fund managers own factsheet to find out what benchmark it uses.

Tiny Clanger May 20th, 2012 at 11:54 AM

Thanks for this. I realised long ago that you couldn't use the "Specialist" benchmark as a benchmark, I was just agreeing with "northerngooner" that the "Specialist" category is not a lot of use. However, it does have one advantage which is the 120 funds that currently make up the category. There are all sorts of weird and wonderful things in there which you wouldn't normally go looking for but, when you see them all under one roof, it does give you a chance to get away from the more mainstream asset classes and a chance to make a lot better returns (or losses).

Personally, I ignore all benchmarks and just use the "Charts" tab from my Portfolio. This gives a 1,3 and 5 year return from each of my constituent funds and my Portfolio overall in an easily read table. I can see at a glance which ones are over/under performing against each other and against my overall pension return (which, I suppose, is therefore technically a benchmark).