The FCA has warned fund groups it continues to harbour concerns about the "potentially misleading" performance reporting used for absolute return strategies, suggesting the products are ripe for an overhaul.
In the final report from its asset management market study, the regulator said it was "still concerned" about how fund firms report absolute return fund performance, as well as a broader disparity of approach from such products.
"We are concerned that many absolute return funds do not report their performance against the relevant target return," said the regulator.
"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 around performance reporting.
"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," the FCA said.
The FCA also decided to consult on rules that only allow performance fees to be charged when a fund outperforms the same "most ambitious" target. This was after evidence emerged that absolute return products in particular charged such fees after beating Libor, despite having a potentially higher target.
The FCA said: "Some [fund firms] charge performance fees for achieving a level of return below the most ambitious target they hold out to investors, for example in absolute return funds. We are considering consulting on rules so that performance fees are only permitted above the fund’s most ambitious target, consistent with our proposals on performance reporting."
The plans to consult on possible new rules follow some highly critical comments from the FCA in its interim report, published last November.
At the time the regulator said it found customers faced a "relatively high likelihood" of negative performance in the 74 absolute return products analysed.
The FCA added in its final report that during its consultation period, several respondents raised concerns about the products, including their complexity, wide range of targets and lack of common definition for the term.
It added: "This included requests for us to investigate how prevalent specific performance targets are, how professional fund investors measure performance and whether performance outcomes were being achieved."
The disparity of both returns and approaches within the Investment Association's Targeted Absolute Return sector has long been a contentious issue. This has been compounded by the popularity of the group, which had the strongest net retail sales among all the IA sectors in 2016.
The sector took in £5.1bn in a year when fund sales more generally were down compared with previous years.
