InvestmentsJun 20 2018

Absolute return funds are a 'ticking time bomb'

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Absolute return funds are a 'ticking time bomb'

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.

Over three years Gars has lost 4.5 per cent, compared with a gain of 3 per cent for the sector average. Over five years it has gained 7 per cent but this compares to 11.5 per cent for the average fund.

While Standard Life's Gars has underperformed its stated benchmark in recent years, many others in the sector have also performed weakly.

A spokesperson for Standard Life Investments, which runs the Gars fund, said the fund needs to be viewed in its own terms, not compared to peers.

"It is worth remembering that Gars is built from investments that we expect to perform over a 3 year time horizon.  

"Unlike conventional funds that aim to exceed their target, absolute return funds like Gars aim to deliver a return as close as possible to their target with as little uncertainty as possible.

"The target for Gars is that it aims to provide a positive investment return in all market conditions over the medium to long term.

"We have always been very clear with investors that Gars has a performance target over rolling three year periods.  

"We use an extended time window because of the longer term nature of the underlying positions used to build the portfolio.”

David Scott, an adviser at the firm of Andrews Gwynne in Leeds, whose firm has used absolute return funds, "quite a lot over the last two years", branded the sector "a very mixed bag".

"We only go with managers that have been doing it for at least 20 years and have been through 2000 and 2008.”

He said a frequent criticism of the absolute return sector - that managers are forced to sacrifice investment return in order to achieve low volatility - is not true in all cases.

His favourite fund for investing in this sector is the Polar Capital UK Absolute Equity.