S&P warns absolute return funds might fail to live up their name

Investors must understand the ‘absolute return’ in the title of absolute return funds is a target rather than a promise by the manager, and allocators should prepare for occasional drawdowns, says Standard & Poor’s.

Products in the category “target meaningful returns over cash and thus take meaningful investment risks,” the ratings agency cautioned in a report on the sector, published this week.

“We are still searching for the perfect fund manager who never makes a mistake,” said Kate Hollis, S&P fund analyst.

“It is also important for investors to remember that absolute return funds vary considerably, and to understand which market conditions suit each strategy and each individual fund within that strategy, before making a choice.”

More than half of 69 UK absolute return funds failed to beat inflation in the 12 months to 30 June, before fees, according to data providers FE Analytics. Only 43% beat rises in the cost of living.

Three beat the consumer price index, which was 4.2% in June, but failed to match the slightly more broadly-based retail price index, which was 5%.

Britain’s Investment Management Association defines absolute return funds as being managed on a rolling 12-month time period with a return of at least 0% ‘in any market conditions’, but admitted the sector may change in the UK as part of its annual review of classifications.

S&P’s peer Fitch Ratings expressed concern that sector growth was being driven by sales more than performance, while noting the European absolute return fund market grew 80% to €140bn from January 2009 and March 2011.

Hollis said: “Most absolute return funds had a difficult 2008, but have come much closer to achieving their targets since.”

She attributed this in part to Libor – against which many funds calibrate their targets – being exceptionally low, and in part to the market recovery of the last 24 months, helping funds that can be net-long of risk assets.

“However, very few funds have achieved their target in every full calendar year since inception, and only one of these – the S&P AA rated Absolute Insight UK Equity Market Neutral fund – was launched before 2008.”

S&P has not yet rated any absolute return fund AAA, even those hitting target each year, because the agency recognizes prevailing ample liquidity that encourages buying of risk assets could decrease, and have “unexpected short-term effects on correlations of many asset classes”.

Hollis said the SEB Asset Selection quant global tactical asset allocation fund, scored AA by S&P, has achieved its objectives since launching in October 2006, because its trend-following bias added considerable value from June 2008, but it has “gone broadly sideways subsequently”.

Hollis noted two ‘wide-spectrum fixed-income funds’, Old Mutual Global Strategic Bond and Old Mutual Global Bond, have changed approaches over 12 months, to allow their managers to be net short duration. S&P would not be surprised to see more, she added.


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