The FCA criticised absolute return funds on a number of occasions in the final report of its asset management market study, published last week. The regulator found fault with the portfolios’ sub-par returns, inconsistent approach to benchmarking, and overzealous use of performance fees.
The IA changed the sector’s name from Absolute Return to Targeted Absolute Return in 2013, and began publishing regular updates on funds’ consistency, in a bid to curtail criticism of the sector. The trade body said it would, if necessary, “set performance criteria, which could lead to a fund’s expulsion from the sector”.
Notably, the FCA’s report used the IA’s monitoring data, which notes how many periods of negative rolling 12-month performance funds have sustained over the past two years, as evidence “customers can face a relatively high likelihood of negative performance”.
Rory Maguire, managing director at Fundhouse, said the watchdog was right to raise questions and the IA should look at ejecting funds.
“I don’t know where these absolute returns funds go…but the IA should [change its rules]. The IA has to, it doesn’t have much of a choice. It’s very clear what the FCA wants from this paper.”
But the IA said in a statement: “The IA Targeted Absolute Return Sector is unlike the asset-based sectors where funds are removed for not meeting asset criteria. This sector is outcome-focused and contains funds that aim to deliver positive returns in any market conditions.”
The trade body also noted that the FCA report highlighted its renaming of the sector as an example of the industry providing increased clarity to investors.
Other fund selectors agreed that the sector should remain in its current state. Hargreaves Lansdown’s Laith Khalaf said the renaming of the sector was a significant change in itself, while Tcam’s Duncan Blyth described the issue as “very difficult” to resolve.
The FCA’s report warned fund groups it harboured serious concerns about “potentially misleading” performance reporting, and suggested the sector was ripe for an overhaul.
“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 study added: “An absolute return fund’s most ambitious target may be Libor plus 4 per cent.
“If we bring in [new] rules, their effect would be to make clear that, where the [fund firm] chooses or is required to display past performance, it must show this against Libor plus 4 per cent, and not against Libor alone.”
The regulator is also considering consulting on rules ensuring that performance fees are only permitted to be taken when a fund returns exceed the product’s “most ambitious” return targets – for instance Libor plus 4 per cent rather than just Libor.
The FCA said several respondents to its interim study had raised concerns about absolute return funds. These included a request to investigate how prevalent specific performance targets are, how professional fund investors measure performance, and whether performance outcomes were being achieved.