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Subdivide and rule

The absolute return sector is back in the spotlight as managers seek clearer classification to bring these misunderstood funds into line, says Joanne Ellul

The investment industry remains divided over the best way to label absolute return funds, after ratings agency Fitch warned there is an increased risk of mis-selling in the sector.

In its report on the European absolute return sector published earlier this month, Fitch says there are a wide range of funds that aim for positive total returns on a consistent basis over the medium to long term but no common definition of what constitutes an absolute return fund.

The report says: “With greater emphasis on liquidity and downside protection, absolute return funds are not meant to fully capture market upside, which results in modest returns, leading to potential disappointment for less sophisticated or informed investors.”

In January, Money Marketing reported that the FSA was privately advising firms against using the term absolute return to describe funds.
The IMA is scheduled to complete its review of the sector next year.

Cazenove head of investment funds Robin Minter-Kemp believes the risk of misselling is not the main problem facing absolute return.
He says: “There is risk of misselling in every sector. The issue is that offering returns above cash to protect wealth is very appealing and so there is going be lots of demand for absolute return funds.

“It is important that the sector is properly repre-sented to clients. It has become a Trojan horse to an eclectic mix of strat-egies and the expectations of investors has not been very well managed.”

Minter-Kemp says the sectors should be divided into two camps, one with equity long/short and market-neutral funds and another with strat-egies such as currencies, bonds, and exchange-traded funds.”

He says grouping funds by their strategies gives an indication of volatility and how the manager is aiming to achieve the outcomes.

JP Morgan head of UK retail sales Jasper Berens says: “I disagree with the misselling issue but the industry has not been careful enough to communicate that returns will not always happen.

“Some investors have misconstrued the term absolute to mean a guar-antee. Retail investors probably do not under-stand what absolute return means. The industry needs to be more explicit about downside risk.”

Berens says the sector should be categorised into sub-sectors based on outcomes such as cash plus 3 per cent, cash plus 2 per cent, cash plus 1 per cent or volatility using standard deviation from 3 to 7 per cent to help investors understand the sector.

Henderson head of multi-manager Tony Lanning, who runs the £108m multi-manager absolute return fund, says: “I agree with Fitch about the risk of misselling. There is an issue with advisers misunderstanding what they are getting.”

Forty per cent of the Henderson multi-manager fund is invested in the absolute return sector.

He says: “The sector should be broken down by volatility. Breaking it into two halves using standard deviation as a measure of risk could work.”
Lanning says flexibility in the sector means there can be a wide gap in performance that makes comparisons difficult. He says: “My fund lost 1.8 per cent in May 2010 and some absolute return funds were down by 15 per cent.”

BNY Mellon head of international distribution Paul Feeney says the absolute return sector should not be scrapped but that there is a need for clarification and better policing of the sector.

He says: “The sector should be divided into two sub-sectors, both cash benchmarked, one with those managers aiming for a positive return over 12 months and those looking at three years.”

Feeney says funds targeting returns over one year should have more constrained, bond-like characteristics and those aiming for returns over three years ought to have greater flexibility and increased volatility.

Feeney says: “The funds should not be distinguished by different strat-egies because it is impor-tant that the general wholesale retail market is outcome-oriented and that you divide funds by risk. Timescale in itself limits the strategies used.”

Octopus Investments chief investment officer Lothar Mentel feels there is too much differentiation within the sector.

He says: “Absolute return is a misnomer. It should be called uncorrelated or alter-native investments. My suggestion for the sector is to subdivide it into three risk buckets – those that are unlikely to achieve a negative return, those unlikely to achieve a negative return of more than 5 per cent and those that could achieve a negative return of more than 5 per cent in a 12-month period.”

Bestinvest senior adviser Ben Seager-Scott says: “Absolute return is back in the spotlight because the industry has not done a good enough job of explaining what these products really are. It is essential that investors know absolute return is a target not a promise.

“In terms of breaking the sector down into categories, it would not be a bad thing as long as the new classifications are suitably descriptive.
“Defining the sector by outcomes is dangerous as you cannot know future outcomes, making any assessment backwards-looking. Past performance is not necessarily a guide to future performance.”



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