Popular absolute return funds that promise returns in any market conditions are putting investors' money in investments that are so complex they have been branded a “ticking time bomb”.
Absolute return funds seek to make returns by using a variety of non-traditional investment strategies. These include using short selling, leverage, and derivatives as well as alternative assets. Many claim to be able to produce positive returns even when all markets seem to be falling.
But Abraham Okusanya, principal of consultancy firm Finalytiq, which researches the fund management and advice, said such funds are difficult even for investment industry professionals to understand.
He said: “The investment industry loves complexity, driven by the twisted belief that complexity should earn a higher fee.
"But complexity breeds risk.
"Complexity makes it harder for investment teams to explain their own strategy. It makes it harder for advisers to conduct adequate due-diligence on a product. And the investor is worse for it. It’s the classic lose-lose-lose.”
Some absolute return funds use the phrase "in all market conditions" to describe their ability to generate returns.
The Financial Conduct Authority (FCA) which regulates the language used by fund firms to describe products and the potential level of return said they are happy with the phrase "in all market conditions".
But the regulator added it should always be followed by a warning the capital invested in the fund is at risk, the investment period over which the authorised fund aims to achieve the positive return, and that there is no guarantee that the investment objective will be achieved over that specific or any time period.
Infamous among absolute return investors is the Standard Life Global Absolute Returns Strategy (Gars), an £18.6bn fund that has been a flagship of the sector, but has shed assets and lost money in the 2017 calendar year.
Mr Okusanya despite the billions of pounds of investors' money that has gone into the fund - often on the advice of finance professionals from advisers to fund managers - few people really grasp how the strategy operates.
“Hands up if you really understand how Gars works? Enough to explain it to a typical client? I certainly don’t. Many advisers and discretionary fund managers who invested in Gars didn’t.
"I’ll wager that many analysts and managers who work at the Standard Life multi-asset teams and indeed the most senior people at Standard Life don’t either.
"This explains why it became harder and harder for them to turn the fund around once it started going south after the original team left.
"If all these professionals don’t seem to understand the fund, what hope has the poor, old Mrs Miggins got?”
He said his comments in relation to this fund apply to the absolute return sector as a whole, which he regards as “complex” and difficult to understand.
Many investors need to be aware these funds are particularly vulnerable to a manager exit, he warned, with the complex nature of the investment products meaning replacement managers are unlikely to be able to replicate the success of the previous manager.