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How do you solve a problem like the IA Targeted Absolute Return sector?

FE Trustnet speaks to a number of investment professionals about the embattled sector after it contributed seven of the top 10 worst performing funds of 2016.

Lauren Mason

By Lauren Mason, Senior reporter, FE Tru...
Thursday January 05, 2017

Industry commentators have called for entry requirements to the Investment Association’s Targeted Absolute Return sector to be tightened after several funds appeared at the foot of performance tables in 2016.

According to data from FE Trustnet, seven of the 10 worst-performing funds in the Investment Association universe last year reside in the IA Targeted Absolute Return sector.

Indeed, out of 194 funds in the universe that lost money for investors last year, 42 of them (or 21 per cent) also resided in the sector.

Table of 10 worst performing funds in the IA universe in 2016


Source: FE Analytics

According to the latest data from the Investment Association (which stretches to October 2016) the IA Targeted Absolute Return sector experienced the highest retail sales during seven out of 10 months last year, only falling into second place during the months of May, June and September.

Targeted absolute return funds have nevertheless come under fire from many investment professionals recently, given the fact that many of them have struggled to produce a positive return over the past year or so.

However, while many in the market area aim to achieve a return in excess of cash in all market conditions over certain time frames, it must be noted that many funds in the sector have vastly differing mandates.

Patrick Connolly, head of communications at Chase de Vere, said: “The absolute return sector has many different funds taking many different approaches and therefore we see a wide divergence in performance from the top performing fund which returned 23.8 per cent in 2016 to the worst performer which lost 25.6 per cent.”

That said, he labels the fact many of the worst performing funds in 2016 are in the IA Targeted Absolute Return sector as “astonishing” and argues that this will be unexpected for those who are invested in the sector.

“The performance of these funds is doing absolutely no favours to the sector as a whole, which is still trying to earn its stripes, or to the investment industry in general,” he continued.

“I would also be concerned with funds which make big gains because these are likely to be taking bigger risks than investors in this sector would expect and could be liable to significant falls in the future.”

“It should be noted that the worst performing funds of 2016 all made sizeable gains in the preceding three years. In 2013 for example FP Argonaut Absolute Return gained 39.6 per cent while CF Odey Absolute Return gave 45.6 per cent.”

Performance of funds vs sector over 4yrs to the end of 2016


Source: FE Analytics

Martin Bamford, managing director at Informed Choice, says the funds in the sector are meant to turn a profit in any market conditions but regularly fail to do so.

Not only this, he says the variability of fund performance in the sector is a significant cause for concern.

“There is a small handful of funds which do a reasonable job, but most of them are bouncing around all over the place and badly letting down investors,” he explained.

“Despite the market volatility we experienced in 2016, many funds in this sector failed to exploit opportunities and preserve capital. To put it bluntly, perhaps the fund managers are not very good at their jobs.”

“When absolute return funds were first launched in the UK, I had some serious concerns about the ability (or otherwise) of funds managers to take hedge fund management techniques and apply them in a retail fund environment. Time and time again it is being demonstrated that these funds are not worth bothering with.”

Downing’s Neil Shillito agrees and likens the sector to 130-30 hedge funds, which were launched several years ago and typically shorted 30 per cent of their portfolios and used these funds to adopt long positions.

“They were very short-lived and, to a certain extent, I think absolute return funds fall into that category,” he said.

“Why have they underperformed so badly? I think it’s because nobody expected 2016 to be a relatively good market for equities. Then we had the concern over Brexit and all the economists and pundits called that wrong. We were all going to go to hell in a handcart and that hasn’t happened.”

“I suspect that quite a few managers were quite heavily short and bought into bonds, the markets have rallied beyond bull expectations and they’ve been caught short.”

Head of research at Whitechurch Securities Ben Willis says the sector has come under scrutiny because of the unusually strong gains made in bond and equity markets.

“Some funds have underperformed and so criticism is justified. However, many absolute return funds have achieved their objectives last year,” he reasoned.

“The majority of absolute return funds are not structured to outperform equity or bond benchmarks. They are designed to produce consistent risk adjusted returns well in excess cash and inflation rates and many have achieved this aim.”

With confusion and disagreements among investors as to how funds in the sector should behave, some have called for the IA Targeted Absolute Return sector to undergo some restructuring.

Connolly says the Investment Association needs to look closely at the classifications of targeted absolute return funds.

“This is a sector which is hugely popular and in which investors place a large amount of trust that the funds there will provide a reasonable level of capital protection,” he said.

“There is a very strong argument for reclassifying absolute return funds that take too much risk and moving them to the IA Unclassified sector. Incidentally the worst two performing funds in the Unclassified sector in 2016 were an ‘Absolute Return’ and a ‘Total Return’ fund.”

Bamford says the Investment Association took a positive step when they added the label of ‘targeted’ to the sector, but believes the sector and funds within it should be banned by the FCA from using the title ‘absolute return’ as it is “grossly misleading”.

That said, he agrees the IA needs to apply strict standards to funds in the sector which lose significant amounts of money for investors in the space of a year.

“They are strict when it comes to booting funds out of the IA Equity Income sector for failing to maintain yield targets over a short period of time, and the same discipline needs to be applied in the IA Targeted Absolute Return sector,” he argued.

“Let these funds languish in the wasteland of the IA Unclassified sector until they can consistently deliver on their stated aims. A move to the IA Unclassified sector might also serve as a warning to advisers and investors that these funds are not all they are cracked up to be.”

Shillito also believes the Investment Association should take a stronger line on funds in the sector and, more specifically, the way the sector is marketed to investors.

“Generally speaking, absolute return funds are a marketing proposition and not an investment proposition. I think the market has promoted these products as, in some cases, a cure-all or at least a sticking plaster for IFA investors who are worried about making major decisions on their own portfolio construction,” he said.

“A lot of them buy absolute return funds and tell their clients that they probably won’t get a particularly high return but they won’t lose any money either. It’s a bit of a panacea I think.”

In response, a spokesperson from the Investment Association said: “The Targeted Absolute Return sector contains funds that aim to deliver positive returns in any market conditions, but returns are not guaranteed.”

“Disclosure is at the heart of the sector and we provide investors and advisers with a monitoring tool on our website which shows them how many times a fund has achieved or failed to deliver returns greater than zero after charges over a 12-month rolling period.”

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Funds mentioned in this article

Data provided by FE. Care has been taken to ensure that the information is correct, but FE neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.

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