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Investment matters – Kira Nickerson

The Investment Management Association’s launch of an absolute return sector begs the question as to what exactly constitutes absolute return? And how exactly does it differ from total return? Or targeted returns for that matter.

The one clear point is that the industry is still moving en masse away from relative returns, unsurprising considering what markets have done of late, but then this trend really began back in the 2001-03 bear market rather than today’s investment climate.

If a fund launch does not currently involve some new asset class or trend, such as environmental, commodities or country-specifics like India, then it will tend to feature at least one of these new phrases. Reminiscent of the late 1990s when most new fund launches were special or select opportunities, absolute, total and’target are today’s buzz words.

For some, the difference can be clear º a total return fund returns capital and income while absolute means returns of 0 per cent and above. Target involves those funds with a set limit to beat, typically Libor plus a certain amount, such as 2 per cent. Of course, Libor being what it has been, this can make for a very volatile target these days and not all funds use the same percentage target. Nor do they all use Libor as a base so that too can create confusion, particularly with funds known as cash-plus vehicles.

Considering the popularity of these types of funds, what is surprising is how few of the new entrants in the IMA’s absolute return sector are familiar retail products, although it does feature the popular BlackRock absolute alpha portfolio.

The sector allows both UK and overseas funds, which are UK-registered and hold distributor status, to list, although so far only five UK-domiciled funds have done so while 12 offshore funds are now present in the newly formed sector.

Within this sector, the IMA has defined absolute returns as those funds which have the aim of delivering absolute, more than 0 per cent, returns in any market conditions.

As with all of the IMA’s sectors, fund groups can apply to list and it would appear that while several funds potentially could, many have chosen to stay in broader sectors or within the growing unclassified sector. Unclassified currently has 184 funds, although only 60 of these are what the IMA deems as retail (excluding private and institutional portfolios with a minimum investment of £50,000 or more).

A glance at this list would reveal that many portfolios are actively using the new Ucits III powers to limit downside or aim to offer absolute or total returns. For instance, unclassified houses funds such as Investec’s target return, the Threadneedle absolute return bond and SG’s total return bonds.

Perhaps these funds are waiting for another IMA sector for inclusion. The trade body is currently consulting on its fixedinterest sectors and whether or not any changes in this area should be made. Among the questions being asked of the current bond sectors is whether or not UK other and UK corporate bonds should be split into three sectors, with the added strategic category. The consultation period finishes at the end of May.

Whether or not a fund takes the name of absolute, total, target or even direction (when it comes to bonds), there is little doubt that an increasing number of funds are using such descriptions in their mandates.

The recent Premier Global DSR Fund does just that. Its aim is to invest in global equities but its goal is for an absolute return, using derivatives and fixed interest to shelter in difficult market environments.

It is not exactly alone. There is a whole swathe of funds that aim or look to provide such returns. In fact, it is now rare to see any mainstream fund launched today that does not have such a goal. But this makes ascertaining who is doing what that much more difficult.

Historically, funds all looked to outperform and preserve capital, making them absolute by today’s standards. Then the market took off and relativity became more important. What was the point in gaining a 1 per cent absolute return in a fund when the index rose by 20 per cent?

It hardly stacked up with the argument of the 1990s, which was justifying actively managed funds over the cheaper passive trackers.

Not so long ago, the FSA took a stand on funds using the word guarantee as it gave investors too much assurance of a return on their investment.

Devising rules on the use of that term limited its use so as not confuse potential investors. But when funds are marketed on the basis of absolute or total returns, are ther not the same questions over investor expectations? Sure, these funds clarify there is no guarantee involved in the goal of providing returns in any market condition but the name certainly gives the impression of one, leaving advisers to explain why the returns may not exactly be absolute or total.

It will be interesting to see how long funds will be able to use such monikers without any stricter guidelines from the regulator. Similarly, one wonders how long a difficult market will continue to make it attractive for fund firms to use such descriptions.

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