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Absolute appetite

As the credit crunch continues to hit funds, investor demand for absolute return offerings has continued to soar.

The last 12 months have seen the UK all companies and UK equity income sectors lose 20.7 and 23.2 per cent respectively while even more defensively minded assets like cautious managed funds lost an average of 8.3 per cent.

While this has happened, investor belief in the absolute return motif has increased, as products that generate returns in volatile markets have grown in popularity.

The IMA introduced its own sector for absolute return funds this year and June saw those nine funds in the range produce the biggest inflows, with £214m of assets.

But returns from some products have shown that absolute return funds are anything but black and white in what they offer investors.

Some funds have failed markedly. UBS absolute return bond has lost 26 per cent in the last 12 months, sitting bottom of 47 funds in the IMA global bond sector, while New Star diversified absolute return and Scottish Widows absolute return UK equity have lost 8.8 and 8 per cent respectively.

Wilson Dean director Nick Lincoln believes that absolute return is a short-term gimmick.

He says: “They do not work, as the past 12 months have indicated, with a number of them losing money. Some are looking for returns of Libor plus three or four, targets which direct equity funds are unlikely to meet. I’ve looked at two or three and I still believe that cash is the better option as you can still get around 5.5 per cent a year, which is a greater return than most absolute returns will be able to offer after the initial and annual management fees.”

One of the biggest problems faced by IFAs is that while funds may fall under the absolute return banner, the individual offerings can be hugely different.

Take UBS as an example. The fund, which is managed by Simon Foster, looks to generate a positive return regardless of market conditions through a diversified global bond portfolio.

Compare that with JPM cautious total return, which invests across fixed-income securities, convertible bonds, equity securities and short-term securities of issuers located in any country.

One is based in the global bond sector, the other cautious managed but some may believe they behave similarly.

JPM head of sales Jasper Berens says he resisted placing the cautious total return fund in the absolute return sector for this reason.

He says: “The industry focuses on relative performance, which is something that should not be happening with absolute returns as some are chalk and cheese. Our fund is fixed rigidly to the cautious managed boundaries and we do not want comparisons with funds that do not have similar guidelines.

“I am in favour of what the IMA has done with the absolute return sector but once that sector grows to 20 or so funds, the introduction of volatility boundaries of Libor one to five will help investors and IFAs to pick the right funds in terms of risk and return.”

Absolute return fund strategies are not just restricted to asset classes. The introduction of derivatives has also allowed managers to protect returns and make money when markets fall. BlackRock UK absolute alpha, which is managed by Mark Lyttleton has been the greatest exponent of derivatives, having produced a return of 13.7 per cent in falling markets in the last 12 months.

Lyttleton uses both shorting as well as pair trades, which is a combination of going long on a stock which you think will go up in price and going short on a stock you think will fall in value. These are usually stocks in the same sector, for example, you could go long on BP and short on Shell which should minimise both sector risk and market risk.

The fund has been the biggest seller on platforms throughout this year and has grown to almost £1bn in size.

Jupiter chief executive Edward Bonham Carter says he would like to get involved in the absolute return sector but he believes the market may still be too early for the firm.

He says: “Some of the techniques in the hedge fund world that are available only to sophisticated offshore clients could be presented in an onshore portfolio, which represents an interesting opportunity.”

Bonham Carter says any involvement will be medium term and depend on the company finding the right fund manager and product design.

He says: “One problem we have is investors believe there is a guarantee in absolute return products so some education is needed from fund managers and advisers.

“Fund managers need the skills in house, in terms of shorting and on the hedge side, but I feel there is scope for the right person and process and it is ultimately an area I would like to get involved in but we want to get it right.”

Hargreaves Lansdown investment manager Ben Yearsley: “I am still wary of the absolute return strategy. I still feel there are questions to answer such as how funds deal with scaleability as they grow from £10m to £100m. I would sooner invest with the likes of Cazenove, who have an experienced hedge fund manager like Tim Russell through Cazenove UK equity absolute return.

Yearsley is concerned that investors will not stick with the funds in the long term.

He says: “What will happen when a raging bull market comes around and investors do not see the value in an absolute return fund that is returning a small amount of what other funds are producing? The acid test will be if they stick with them and I am not sure investors will. This is why a greater education for all is needed.”

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