Autumn Investment Monitor 2017  

Demand grows for dominant strategy

Demand grows for dominant strategy
Monthly net retail sales for IA Targeted Absolute Return sector

As a concept or a strategy, absolute return never fails to stir an emotion from fund buyers. Despite opinions being split, funds offering downside risk protection, but with an aim to beat inflation or cash, have grown in popularity. 

Initially backed by pension funds, absolute return now dominates the retail space, boosted by pension freedoms and a growing desire for capital protection at the expense of growth.

However, as ever it is never that simple. Absolute return can mean different things to different investors. The IA sector itself, with its 113 products, includes funds aiming for downside protection and cash matching returns, more aggressive versions of these, or basic long/short funds. At the heart of it all is always, in theory, a lack of correlation to equity and bond markets.

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The desire for this has seen the sector experience phenomenal growth – in both periods of risk-on and risk-off sentiment.

In 2016, as investors looked out towards political uncertainty and attempted to recover from surprise risk-off sentiment in the opening weeks of the year, absolute return strategies found their stride. The IA Targeted Absolute Return sector was the best selling sector in 2016, bringing in £5.1bn of net sales in what was a record poor year for fund groups as total net sales only hit £4.7bn.

This year, as risk markets recover from a turbulent 2016, sales have reduced but held up. The sector has seen £2.5bn of net inflows by the end of July, as the funds industry pulled in £23.1bn.

Given this demand, the space has come under the eye of the regulator. The FCA was at pains to warn fund firms it about its concerns with “potentially misleading” performance reporting from absolute return strategies in its final report of the asset management market study.

This came after its interim report last year highlighted that investors faced a “relatively high likelihood of negative performance”.

“We are concerned that many absolute return funds do not report their performance against the relevant target return,” the FCA says in its final report.

“We also agree that the wide range of charges and targets could be confusing to retail investors, and is unlikely to help investors compare performance even within the absolute return sub-sector.”

The products were consistently mentioned in the report, which also saw the watchdog decide to consult on new requirements concerning performance reporting.

The FCA adds: “An absolute return fund’s most ambitious target may be Libor plus 4 per cent. If we bring in such rules, their effect would be to make clear that, where the [fund firm] chooses or is required to display the fund’s past performance, it must show the past performance against Libor plus 4 per cent, and not against Libor alone.” 

Despite the scathing comments, the Investment Association says it had no plans to change the way it defines absolute return strategies, a debate that has only grown along with the size of the sector. Some fund buyers suggest the IA remove funds that repeatedly miss targets or incur losses for investors.