Dividing the IA Targeted Absolute Return funds by investment style is the most popular proposal for restructuring the sector among FE Trustnet readers, but analysts prefer a more blended approach.
Last month, FE Trustnet looked at the sectors experts wanted reformed, asking our readers to cast their vote, with the IA Targeted Absolute Return sector emerging as the runaway winner, carding 51 per cent.
In our latest poll, the most popular form of splitting up the sector among our readers is by investment approach, taking 33 per cent of the vote.
Adrian Lowcock, investment director at Architas, defined this as recognising what the fund is attempting to achieve and what methods they use to achieve this.
He said: “I think you’ve got to look at strategy because you have got things like the [Standard Life Investments] GARS fund which is, generally speaking, trying to be a bit more cautious.
“You can’t compare that to things like the Crispin Odey funds, which are much more adventurous and risky, so to have a risk approach is quite important there.”
As such, potentially the sector could be split by cautious, balanced and aggressive absolute returns based on the philosophies of the various constituents.
Results of FE Trustnet poll
Source: FE Analytics
Meanwhile, the least popular option for restructuring the sector was suggested by Standard Life Investment multi-manager head Bambos Hambi, who proposed splitting the sector by asset class, although this method still attracted a respectable 20 per cent of the vote.
Hambi, who runs the Standard Life Investment MyFolio fund range, said he breaks the sector down into absolute return bond and absolute return multi-asset as part of his investment process.
Psigma senior investment analyst Dan Adams agreed, noting that comparing a long/short equity fund with a long/short credit, fund for example, is “quite frankly a bit pointless”.
However, restructuring the sector to incorporate a combination of factors may be the most prudent and efficient approach according to Darius McDermott, managing director of Chelsea Financial.
While breaking the sectors down by performance target (which gained 24 per cent of the vote) and risk target (23 per cent) were second and third choice respectively, a combination of the two could work.
McDermott said: “I don’t really mind if you are using emerging market debt or multi-asset or equity long/short, [but] what target are you going for?”
He said that splitting the funds down by benchmark could be a good start, with the sector’s 50 largest funds currently using 38 different benchmarks.
While this seems like a lot of benchmarks, he said realistically a “good chunk” of the sector is targeting between cash+2 and cash+5 per cent.
“Now clearly a fund targeting cash+2 and a fund targeting cash+5 have got to have different risk budgets so they are very different beasts,” he said.
“There are lots of funds targeting ‘cash plus’ so I would break it down into cash+ 2-3, cash+ 4-5 and anything above because that’s how we look at it and I think it is more appropriate to look at the target return and the target volatility.”
In a recent report, financial services specialist The Wisdom Council agreed that this may help investors, noting: “What has emerged is that investors relate easily to the term ‘cash plus’ where they feel they can better understand their returns when linked to a cash benchmark.”
This would help to eliminate some of the discrepancies seen within the sector, and McDermott highlighted City Financial Absolute Equity as an example of how the sector could be improved.
He said: “City Financial Absolute Equity fund is a full throttle hedge fund basically so that uses equity long/short but is not really comparable to BlackRock UK Absolute Alpha which is also equity long/short. They use the same tools but they are totally different types of funds.
“That’s why we prefer not to break them down by what they do but what their target is and what the risk or volatility target is on the fund.
“That City fund – I’ve known David Crawford since the fund was at Octopus and he is a very good long/short manager but it is totally different than the BlackRock fund.”
Performance of funds over 5yrs
Source: FE Analytics
Indeed, as the above shows, the funds have provided very different returns over the last five years, with City Financial Absolute Equity fund up by 141.64 per cent while BlackRock UK Absolute Alpha has gained 21.56 per cent.
Yet both funds are benchmarked against three month LIBOR (London Interbank Offered Rate), meaning that performance benchmark is not a perfect solution.
As such McDermott suggests volatility as an additional measure. City Financial Absolute Equity has experienced volatility of 12.26 per cent while BlackRock UK Absolute Alpha (4.37 per cent volatility) has provided much smoother returns.
“Any fund that can deliver you 40 per cent in a year and minus 18 in a month isn’t an absolute return fund in my mind it is an out-and-out hedge fund,” McDermott said. “It may be an alternative fund but it is not absolute return.”
“And then there are other funds like Andy Crawker’s BNY Mellon Absolute Return Equity fund or Premier Defensive Growth. These really are very low-risk funds but again they do it differently.”
“BNY Mellon’s Andy Crawker is market neutral and trying to squeak out little bits of alpha mostly via a pair trade strategy.”
Performance of funds over 5yrs
Source: FE Analytics
“And then Premier Defensive Growth who come up with investment ideas and try to find the lowest-risk way of implementing those ideas and if you look at the volatility and the drawdown they very rarely lose money in a month and if they do it is very small amounts,” he added.
These differences in approach but return profiles and focus on lower volatility show why there is no one way to divide the sector and that grouping similar funds using a mix of categories may be the best solution.
However, there are fears that subdividing to this extent may make too many sectors with very few funds within them – a common criticism when asking advisors.
Psigma’s Adams said: “Breaking them out into risk/return and down to a sector level probably makes sense but the only issue you’ll have there is you would have loads of different bands.”
Rob Morgan, pensions & investments analyst at Charles Stanley Direct, added: “I'm against sub-dividing too much as there are already a lot of sectors. 
“It's also quite difficult in some cases to split a sector in two. E.g. Absolute Return is probably better split into three or four to reflect the diverse nature of the sector but this would just create too many sectors.
“Therefore I would essentially leave things as they are and acknowledge the need for comparing the fund against its own benchmark rather than the sector.”
While there may not be a definite answer, one place to start could be by either confirming the definition of ‘absolute return’ or renaming the sector.”
The Wisdom Council added: “From our continued research with over 2,000 end investors, none of our groups are able to come to a consensus on the definition of absolute return.
“Perhaps unsurprisingly, the instinctive conclusion was that the funds carry some level of guarantee, either of the return or of the investor’s capital - that should be of grave concern to product providers and the regulator alike.”
And it said sectors are having a “growing influence” on end investors, who often rely on them to help with their investment decisions.
“Even sophisticated execution-only investors do not have the time and resources to research every fund in a sector before investing, so retail investors are heavily reliant on signposting and filtering to help them narrow down the selection,” The Wisdom Council said.
"Our research with end investors clearly indicates that they want fund names (and therefore also naming conventions) to provide a clear signpost as to what the fund does and they should be purpose-based where possible (growth, income etc).”
Psigma senior investment analyst Dan Adams agreed that a name change may be the answer, as absolute return is “misleading with its name”, suggesting the name ‘all-weather’ or something more neutral.
While renaming the absolute return sector may make sense, the most popular form of splitting up the sector among our readers was by investment approach, taking 33 per cent of the vote.