Investors need to understand they can still lose money with absolute return funds, according to industry experts who say too many expect these types of funds to provide guaranteed returns.
The IA Targeted Absolute Return sector was the best-selling sector every quarter last year with annual net retail sales of £5.1bn yet many remain sceptical as to whether investors are aware that the sector does not guarantee positive returns.
On average last year, the sector returned 1.06 per cent to investors, but as the below graph shows the highest (Schroder ISF Emerging Markets Debt Absolute Return) returned 23.77 per cent while the lowest (FP Argonaut Absolute Return) lost 25.63 per cent.
Performance of sector and funds with the highest and lowest returns in 2016
Source: FE Analytics
In fact, 38 of the 104 qualifying funds in the sector failed provide a positive return in 2016.
Anna Lane CEO and co-founder of The Wisdom Council, said: “First and foremost I think these types of products have huge appeal because this concept of a return no matter what the market condition is very appealing to consumers, especially if you think about ‘Gen X’ boomers who are looking at steady income streams.
“So people really like the concept. The challenge and certainly the FCA have been looking at this is people understanding that these are not guaranteed.
“We would say that we see absolute appeal for these products and a need for them but what we come across repeatedly is confusion around the term absolute and that in itself is quite is dangerous.”
Chelsea Financial Services managing director Darius McDermott, agrees, noting that the defining what absolute return is the biggest problem for advisors dealing with clients.
“I will go so far as to say that historically I think the investment association have done a bad job with the sector,” he said.
“As it sits there is emerging market debt absolute return, absolute return bond funds, funds that use derivatives, funds that don’t use derivatives and in their wisdom around three years ago the big change the IA made was to change the name of the absolute return sector to the targeted absolute return sector.”
However, not everyone agrees, as AJ Bell head of fund selection Ryan Hughes says there needs to be a greater emphasis on the investor to understand what they are buying into. 
The analyst, who has previously been involved in IA committees, including this sector’s committee, says “everybody can improve and explain things better”.
“If we think back to the premise of the IA sector it is over a rolling 12-month period in any market conditions so I think it’s easy to see why people can get confused,” he said.
“But equally I would suggest that it is important for investors to do their due diligence before they invest in anything and if they don’t understand it or don’t realise that there is a risk that it might not deliver on those positive criteria then there is a chance they’ll lose money.
“The first line of the IA’s absolute return definition says ‘funds managed with the aim of providing positive returns in any market condition. But returns are not guaranteed so it couldn’t be any clearer from the IA that there is risk inherent in these funds.
“But it’s a tough one because the IA has got a tricky job in grouping funds like this together when it knows that there is no perfect way of doing it so I do think there is a strong emphasis on the potential investor to understand what they are buying.”
While the IA confirms that the returns are not guaranteed, it is easy for investors to be confused, but the experts say there are some aspects investors should be able to expect from an absolute return fund.
McDermott said: “I am old enough to remember when hedge fund strategies, and most of these are hedge fund strategies, were not available to the consumer and you had to have a minimum of £100,000, which is not a typical buying order for my type of client, but why shouldn’t all clients have access to lower volatility strategies.
“Strategies that over time and most of the time should make positive returns even if they are modest positive returns.
“It’s all about diversification within a portfolio and trying to educate clients that that’s what they sit there for.
“Any fund that can make 40 per cent in a year and lose 18 per cent in a month should not sit in this sector, yet it does and that is just not comparable to what some do.”
One such fund is the five crown-rated SVS Church House Tenax Absolute Return Strategies run by James Mahon and FE Alpha Manager Jeremy Wharton.
The £82m fund has returned 27.71 per cent over the last five years, making a positive return in every year since 2011.
Performance of fund vs benchmark over 5yrs
Source: FE Analytics
Fund manager Mahon said: “Our approach has been that we had a need for our own private clients for a particular instrument so that’s what we designed for a particular job.
“When Jeremy and I put this fund together in 2007 we were concerned about the state of markets and we had one particular client who had come into a lot of money and we wanted to put in place something that would take a low-risk, absolute approach that would therefore provide a bedrock to the portfolio.
“As far as I’m concerned an absolute return fund that is appropriate for private client portfolios needs to comply with three rules.
“Rule one is has it got a target that is aiming to beat cash or inflation whichever is the highest at the time – a simple absolute target.
“Rule two – is that an objective that is always there – is it there on a rolling 12 month basis – is it something you are always trying to achieve.
“Thirdly what are the controls and processes that will lead to low volatility and low-risk loss and if you can’t answer that and can’t answer those three then I don’t think you should be in our sec