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Off target

Target return funds have failed to deliver so why do investors brother?

I have been sceptical of target return funds ever since DWS launched Ratebuster, the ill-fated fund that was pulled less than a year after being launched. True, its demise was accelerated by the Aberdeen takeover but it looked a dead duck from day one.

This was after all a fund that was promoted as “the building society alternative”, promising capital security and an annual return of about 7.75 per cent using derivatives and other complex financial products. The fund returned zilch and was nowhere near achieving its target when it closed.

But it did not prevent several fund groups launching similar funds – be they target return or absolute return. Many share the same objective – beat Libor or base rate by a couple of percentage points each year. SocGen is the latest to launch a fund – aiming to beat Libor by 3 percentage points.

But I have always wondered why investors would bother with such funds. After all, you have fund managers using derivatives or currency swaps, CDOs and emerging debt, all for the trouble of a couple of percentage points more than you would get with cash. There is also the added risk of returning less than a savings account.

Naturally, fund groups have attempted to persuade me that I am wrong – that there is a place for these funds.

The problem is that three years after some of the funds were launched, performance has been off the radar. Standard & Poor’s recently said as much – 21 funds across Europe all failed to hit their targets last year. Many of the great and the good that attended the Fund Forum conference in Monaco a fortnight ago also criticised the new breed of funds for poor performance.

Baring directional bond is one of the worst of the bunch. Its manager admits that “it is not been the best period of his investment career”. He is not wrong. The fund aims to deliver four points above Libor after charges. Over the past, the fund has gone in the wrong direction entirely and has fallen in value by 6 per cent.

But it is not alone. Credit Suisse target return (six-month Libor plus 2.5 per cent) was marketed as “a core product for the risk-adverse investor seeking positive returns whatever the market conditions”. It has returned 15 per cent (not including any initial charge) since launch in April 2004 while Libor has hovered around and above 5 per cent.

According to the stats, UBS absolute return bond has returned a paltry 6 per cent since it was launched more than two years ago.

Ironically, one of the best performers is Nationwide’s product, managed by BlackRock, a fund that does not rely on derivatives or takes bets on currency but traditional asset allocation. But it is still falling short and you wonder if its customers in particular would be better suited elsewhere.

Experts claim that in the past year managers have struggled to call the market correctly, with inflation rising but interest rates down on long duration bonds. Jitters in emerging market bonds and currency markets did not help either. But this is my problem. Managers are taking bets on currency movements and interest rates and all for a measly percentage point here or there. Frankly, they do not appear to be very good at it either.

The groups argue that target or absolute return funds will come into their own when markets fall or suffer a few wobbles. They claim it is early days to judge performance and have no doubt that investors will be convinced once longer-term performance patterns are established. Is three years an unreasonable period of time to judge performance? They also believe target funds have a role to play as they are low risk and offer diversification.

Richard Eats, retired from Threadneedle (its absolute return fund has delivered a return of 2.5 per cent in getting on for three years) once said that over time people will accept the funds for what they do rather than how they work. “TV sets are complicated and I don’t care how they work so long as I can watch the rugby,” he says. “It’s a case of getting used to them.”

The problem is that all people have learned so far is that they tend to under-hit their targets and struggle to beat the returns on cash.

Paul Farrow is money editor at the Sunday Telegraph.


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