The absolute return sector is particularly interesting when it comes to the difficulty of comparing different funds.
The absolute return label covers a whole range of possible investment strategies, including funds that focus on European equities, UK equities, global bonds and multi-asset strategies. In addition, they can use long/short strategies, derivatives or currency investments to act as a hedge to their core investments.
At first glance, the top 10 performers over one year include three global funds, three UK, two European, one government bond and one labelled absolute return. Within this, there are seven equity funds, two mixed asset and one fixed income.
But all these funds do share one common aim – to provide a return of better than zero in all market conditions.
As Scottish Widows Investment Partnership fixed income investment director James Carver says: “The prime selling proposition of an absolute return fund is that it aims to deliver a positive capital return over the longer term, regardless of market conditions. That allows the absolute return manager the freedom to maximise his stock selection capabilities.”
On this basis it is possible to compare individual funds on how well they have achieved this basic goal.
Over three and five years, the funds performed reasonably. FE Trustnet figures show that over five years to April 27, the 12 funds in the IMA absolute return sector returned an average of 12.2 per cent, with only two funds – Insight diversified target return and BNY Mellon evolution global alpha – in negative territory.
Over three years, the 28 funds with three-year track records also produced a sector average return of 12.2 per cent, with only four funds in negative territory.
However, over one year, the performance of the sector falls away. The large number of new launches means there are now 76 funds in the sector, although only 69 funds had 12 months of performance data at the end of April.
The average return over 12 months was down to -1.3 per cent, with only 28 funds, less than half the total number of funds in the sector, producing positive returns.
The top-performing funds over three and five years have produced strong returns in testing market conditions. Two funds returned in excess of 20 per cent over five and three years. The Newton real return fund returned 36 per cent over five years and 24.2 per cent over three years, while the Insight absolute insight fund returned 24.7 per cent and 20.7 per cent respectively.
The Threadneedle absolute return bond is the one other fund that returned more than 20 per cent over five years, while five others returned more than 20 per cent over three years – Henderson credit alpha, Standard Life Investments global absolute return strategies, S&W The Tenax fund, Insight diversified target return fund and Scottish Widows HIFML absolute return fund.
The sector average returns are less impressive when compared to returns on cash.
A total return of 12.2 per cent over five years equates to just over 2 per cent a year, a rate easily matched by many deposit rates for cash, even taking into account the low rates on offer over the past four years. Over three years, the average return rises to around 4 per cent a year but even this fails to outshine cash.
According to Moneyfacts, the best five-year fixed rate bonds for cash deposits paid out just over 4 per cent consistently over recent years.
When you look at the returns available last year, the picture is even less impressive.
The negative 1.3 per cent the sector returned over the past 12 months compares poorly with the rates of just under 3 per cent currently available on one-year fixed rate bonds and 2.6 per cent on cash Isas.
There are efforts to find other ways of comparing funds. For example, FE Trustnet expanded its fund rating system to cover absolute return funds earlier this year.
Investment product consultant Rob Gleeson says: “Absolute return funds have been hard to rate because they are not managed against a traditional benchmark. FE has devised a way to measure outperformance using Sortino ratios as well as alpha versus a benchmark. This allows us to score absolute return funds on a like-for-like basis with other sectors to allow investors to compare them with funds targeting relative outperformance.”
The Trustnet ratings look at the level of outperformance of a fund, its volatility and the consistency with which it has beaten its benchmark.
Covering performance over the past three years, only three funds, Henderson credit alpha, Insight absolute insight and Standard Life Gars fund, achieved the top FE rating of five crowns.
But this still leaves the difficulty of establishing which other funds to use for a like-for-like comparison.
Despite the difficulties in comparing funds, the sector remains popular with investors. Total assets invested are now worth £22.8bn and it was the 12th most popular IMA sector according to February sales, with £77m of fund inflows.
This sharp growth has attracted the attention of the FSA, which included absolute return funds in its retail conduct risk outlook released in 2012.
The FSA has raised concerns about the variety and complexity of funds in this sector, which could lead to a lack of understanding of these products by both investors and advisers and their potential to be unsuitable for some retail investors.
The FSA said: “Advisers must also ensure they meet their obligations in relation to their understanding of the product and the risks involved and the extent to which recommended products meet the needs of their consumers.”
Due to the difficulties involved in comparing the different investment strategies used in the sector, the FSA has warned that advisers had better know their onions when it comes to absolute returns.