McDermott: During the credit crunch, fearing further erosion of their capital, investors piled into the absolute return sector. Unfortunately, not all of these funds have done exactly as it says on the tin, that is, if you consider the definition of absolute return – to return more than zero in any market condition.
I feel much of the problem lies in the diversity of the funds within the IMA’s absolute return sector. For example, two equity-based hedge fund strategies – Cazenove absolute return and CF Octopus partner absolute return – are fundamentally different, with the Cazenove product offering a lower-risk option.
Even more confusing is that within the sector there are funds based on entirely different hedge fund strategies, for example, fixed interest, multi-asset, equities and ETFs. It is my belief that absolute return is here to stay but the IMA must ensure the funds in the sector are comparable.
Yearsley: I don’t think there ever was a situation where they were not accepted. Over the last 18 months, absolute return funds have moved more into the mainstream as the universe has expanded. Many groups now have quality funds and I expect them to move more into the mainstream as managers prove their ability to perform in different market environments.
Has the FTSE 100 bottomed yet? Where will it be by the end of the year?
Hall: I don’t think it has bottomed yet. We have had a sucker’s rally. The harsh realities of a long drawn-out recession are beginning to be felt and the market could be down below 4,000 at the end of the year.
McDermott: Have we seen a dead cat bounce or was the recent market rally a recovery marker? The truth of the matter is that no one can be 100 per cent sure about where the market is going at the moment. One of the problems is that we are analysing a forward-looking market that is dislocated from the endemic economic problems we face.
With so many unknowns (bank lending, housing, unemployment etc), all one can do at best is attempt to predict the foreseeable level of volatility. I can see the FTSE trading in the range of 3,500 to 5,000 for some time to come.
Yearsley: The market could end the year at 5,000 or at 3,500. At the beginning of the year, we said 5,000 was a prediction for the year-end. I do not see any reason to differ from that. The only caveat I would say is take any FTSE prediction with a large pinch of salt.
Are we likely to see the further consolidation of fund manag-ement houses and/or funds?
Hall: I certainly think we will see a consolidation of funds. They are expensive to run and a lot of areas are not attracting new money. There is a wave of new money out there but investors are not investing in the more esoteric areas. There will be a lot of people looking to invest in quality.
Smaller funds that are haemorrhaging money will continue to do so. If fund managers do not get smart about where they are spending their money they may struggle with their working capital and have to find someone to partner up with.
McDermott: We have seen and will continue to see the consolidation of the fund management industry. In the current environment of depleted asset values, cash-rich investment houses will be eyeing up other struggling investment companies for opportunities to get their hands on cheap assets.
Internally, all houses will be examining whether funds are economically viable to run and affordable to investors. If not, these will be merged into larger funds with similar mandates.
Yearsley: Costs are still a vital issue to all companies, especially quoted ones, therefore there is bound to be pressure to increase profits and buying or merging funds does that. Small funds are generally uneconomic so it makes sense to merge/ consolidate if there are overlaps. Groups such as Henderson New Star are prime candidates for merging funds later this year.
Takeovers will probably happen. However, the acquiring group would have to have a strong balance sheet (such as Schroders), as it may be difficult getting finance from the banks or markets in the current environment – although don’t bet against Aberdeen acquiring more businesses.
Is commercial property attractive right now?
Hall: At the beginning of the year, I thought there was some attraction in certain Reits where they were trading at discounts but these have narrowed to the point where I do not see it as attractive. There are no real discounts to be had at the moment so I will be holding off for now.
McDermott: The commercial property market is a bellwether for the wider economy. I do not believe it has reached the bottom but it hasn’t far to go. From a historical point of view, commercial property prices look cheap. While macro-economic indicators continue to look grim, this asset class will turn around in the long term and, in hindsight, now will be viewed as an attractive entry point.
Yearsley: Commercial property is looking a lot better value than six months ago. However, if you look at property funds, prices are still falling and what is the point of buying into an asset class that is still depreciating? We are probably near the bottom. However, I think investors can afford to wait until property fund prices actually turn positive for a month or two before committing any money. Even if you miss the first month or so, the most you will lose out on is the first 1 or 2 per cent of growth.
Do you think the inflows into fixed interest are justified? Are we in danger of replicating the mistakes made with tech funds in the corporate bond sector?
Hall: Fixed interest covers a multitude of areas. Sovereign debt is attracting a lot of money that is not being moved into index-linked or high-grade corporate bonds. I would rather put the money into a fixed-interest tracker fund. There are huge amounts of money going to managers who have a particular style and are either shy on banks or not, and that is too big a call to make in the marketplace.
McDermott: There is a key difference between the two – the tech boom was a proactive momentum-driven rush with the carrot of huge (and ultimately unsustainable) profits, the flight to bonds was a reactive measure taken by yield-hungry investors hoping to get some income in a climate of near-zero cash rates and reduce their exposure to equities. Sceptics fear a wave of defaults but I believe the bond market will weather the storm and that the yields are currently overestimating the rate of default.
Yearsley: The inflows are justified. Prices fell too far, giving investors a great short-term opportunity. In the last few months, prices have rebounded and a lot of the early profit has now been made, that is not to say they aren’t still good value, just not as good value as three months ago.
I do not think it is the same as the tech issue. Corporate bond funds were very cheap and are still cheap and offer good value.