The Investment Management Association looks set to overhaul the absolute return sector as part of its wider sector review.
Since launching in May 2008, the sector has become one of the biggest sellers in the market, with both Schroders and Standard Life offering funds with more than £5bn of assets. The average size for an absolute return fund is now £507m. Contrast that with November 2009 when total funds under management in the sector stood at almost £7bn.
However, it has not all been plain sailing. Since the launch, advisers and providers have been questioning the premise of absolute return funds as well as the structure of the sector and whether it offers a true guide to the best performers.
Skerritt Consultants head of investments Andy Merricks says if you recommend a fund, the most important factor is you understand how it works before you judge whether it is suitable for clients.
He says: “Fund performance should not be the first thing an adviser looks at when selecting a fund in the absolute return sector. It is important to recognise there are funds that do completely different things in terms of investment strategy. The problem is there are some funds in the sector that really should not be there. You do not want to see a fund return 20 per cent in a year because while there is no problem in it participating in the market to that extent, the chances are that if markets fall, that fund may fall back with it.”
One of the problems faced by absolute return funds is that they do not perform well in bull markets which many of them faced in the strong markets of 2009 and 2010.
Hargreaves Lansdown investment manager Ben Yearsley says: “People have slightly unrealistic expectations of absolute returns and what they can provide. There are questions as to what they do and whether they can provide positive returns throughout all periods. These products are long-term holds for 10 or so years and will perform over that timeframe. Even strong managers have a bad year every now and then, as did Jupiter’s Philip Gibbs in 2010.”
Fund firms say the FSA is privately advising them against using the term absolute return when launching new funds as it creates the impression growth is guaranteed.
OPM Fund Management chief investment officer Tony Yousefian was planning to launch a fund using the absolute return label but says the FSA expressed concern over the term. He has opted for diversified target return instead.
Fidelity International has also raised concerns that investors may be misled by the term, saying it offers some kind of guarantee to investors.
Fidelity co-head of investment strategies group Richard Skelt says for investors who translate absolute return into guarantee, the term implies a promise not all managers can back up.
Fidelity has avoided using the term completely. Skelt says: “Last year, when we added a new category to our list we avoided using the term absolute return and instead labelled it alternatives, as we believed that while it is a group of funds that needed to be on the list, absolute return implies a promise not all managers can deliver on.”
Last month, Money Marketing revealed the IMA is looking at splitting the absolute return sector into two separate sub-sectors, covering one and three-year timeframes respectively.
A major concern among many providers has been the inability of absolute return funds to produce some sort of positive return on over a 12-month period. In August 2010, the IMA said that funds not stating the aim to deliver an absolute return in their fund literature could be kicked out of the sector. There are currently seven funds in the IMA absolute return sector with negative returns over 12 months and the worst of these, the CF Octopus absolute UK equity fund, is down by 9.9 per cent.
If the sub-sectors were introduced, the 12 funds with a three-year track record would show an average return of 12.63 per cent. Two funds still produced negative returns, however, with the EFA absolute return portfolio down by 5.22 per cent and the BNY Mellon evolution global alpha fund down by 1.62 per cent, according to figures from Lipper. At the opposite end of the scale, Henderson global credit alpha was up by 37.41 per cent.
Martin Currie head of product development Toby Hogbin welcomes the move to split the sector as it continues to gain critical mass.
He says: “It becomes appropriate for investors to be able to compare like-for-like products and that is something likely to continue as the absolute return sector grows in maturity.
“How that split is based, whether it is over timeframes, fund characteristics or volatility, is likely to be a long discussion.”