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Shocker result for absolute return investors: Funds meant to turn a profit in any market weather get hung out to dry

SIX absolute return funds dominate worst 10 performers chart for March

Sector was the top-seller in investment industry in previous month

New Year crash led investors to plunge cash into funds designed to always make money

Published:07:30 BST, 8 April 2016Updated:09:08 BST, 8 April 2016

Absolute return funds are designed to turn a profit come what may. Instead, they throng the very lowest rungs of investment performance tables for March, in what one expert called a shocker of a result.

There are no less than SIX absolute return funds in the bottom ten. Yet this was the biggest selling sector in February ouch, said .uk managing director Brian Dennehy.

A flight to the perceived all-weather safety of absolute return funds saw investors pour a net 243million into the sector after the New Year market crash, latest industry sales figures show.

Come rain or shine: Even the most successful investment funds can lose money sometimes, but absolute funds are supposed to pursue strategies that deliver positive returns in any market conditions

These funds have the stated aim of achieving a positive return no matter how well or badly markets are performing, although industry data reveals huge variation in their ability to do this – and a number appear to have seen their strategies come unstuck in March.

Why have investors piled into absolute return funds lately?

Dennehy reckons investors turned to absolute return funds in February because they became afraid after financial markets fell in the New Year.

Absolute return investing is when a fund manager tries to achieve a positive return no matter how well or badly markets are performing.

They might invest in a wide variety of ways to achieve this goal – including shorting which means making a bet that an asset will fall in value, or using complex financial instruments or strategies.

The volatility of stock markets since the financial crisis began in 2007-2008 has prompted more investors to take an interest in the sector.

They have come under fire for high charges – including in some cases easily achievable performance fees – and complexity as well as poor performance.

Industry data highlighted below shows that while some funds have an almost unbroken record of failure, others managed to stay in the black every month.

Some absolute return funds are very popular indeed. The best-known isStandard Life Global Absolute Return Strategies, which employs about 30 different strategies simultaneously so risks are very diluted, and has a staggering 26.5billion under management.

It has made a 21.4 per cent return over five years against an overall sector performance of 12.1 per cent, although the fund has struggled somewhat over the past year.

Equities had a bad start to the year although they bounced again early in February. Bonds have had a mixed year unless you are in government bonds – they have done well. Commodities, its been a rollercoaster, he explained.

Despite there being no guarantees of positive returns in the absolute return sector, he believes this volatility made ordinary investors, fund of funds managers and discretionary brokers who run portfolios on behalf of clients, decide to shift money into these funds.

Regarding recent performance, Dennehy said: Its not absolutely clear to me why so many have failed so badly across the month of March. Stock markets were bouncing. Bonds on balance were slowly having a recovery. Gold and oil have been bouncing lately. Currencies have broadly been more stable than in past months.

It appears some of these absolute return funds must have made different bets. They might have been expecting something more negative and got something more positive. Most markets were quite positive so they were on the wrong side of the recovery.

Jason Hollands, managing director of Tilney Bestinvest, also stressed that absolute return funds were not guaranteed investments, but pointed out they typically aim to deliver positive returns over a rolling medium-term time period, such as three years not one month.

Its unsurprising in many ways that March was a tougher period for many absolute return funds, as it saw a sharp bounce in many of the areas where absolute return funds will have short positions [bets that prices will fall].

Commodities including oil and gas, mining companies and Asia and emerging markets all rallied sharply during the month. Thats in part down to the Chinese authorities increasing stimulus measures and hopes for a production freeze amongst oil producers all factors which could be short lived.

How successful are absolute return funds usually?

The highly variable results of funds designed never to lose money are laid bare by an industry study showing only 12 per cent achieved this goal in a survey of their rolling 12-month performance over the past couple of years.(See box and full list below.)

An industry study of rolling 12-month performance over the two years to the end of February 2016 found these absolute return funds made positive returns in every month during the period:

Old Mutual Global Equity Absolute Return Hedged

This fund lost money in 23 of the 24 months under scrutiny:

These funds lost money in 18 out of 24 months:

Study of targeted absolute fund sector by Investment Association using Morningstar data, which isupdated monthly here. Click on the link marked Targeted Absolute Return Fund Rolling 12 month Performance Data to find the pdf document. A full list is below.

Thats little changed from the 13 per cent success rate This is Money discovered when wedelved into these figures in 2013.

In the latest study, eight out of 65 funds racked up a perfect record. A further six funds managed not to lose money in any month since they were set up, but are too new for a full record to be compiled.

On the other hand, seven funds racked up negative 12-month returns at least half of the time over the past two years. One was in the red for a shocking 23 out of 24 months of those analysed, and two lost money in 18 out of the 24 months.

The rolling performance analysis was carried out by the Investment Association, an industry body bankrolled by fund managers, using Morningstar data. A few years ago, the IA officially renamed the sector to Targeted Absolute Return to ensure there is no doubt that positive returns are a target and not a guarantee.

The IAs former boss Daniel Godfrey, who wasousted from the organisation last year,explained the move back then as follows: One key purpose of the absolute return sector review was to make sure that consumers do not inadvertently perceive there to be some implicit guarantee of positive returns due to the name of the sector.

He added: We will also keep a close eye on performance and, should it become necessary, set performance criteria, which could lead to a funds expulsion from the sector on performance grounds.

A switch to judging funds on performance has not taken place since then, and no fund has been ejected from the sector by the IA, although one has left of its own accord after changing the investing objective.

How do you choose a fund in the absolute return sector?

Past performance is never a guide to the future, but current figures show the targeted absolute return sector as a whole has delivered a positive return of 12.1 per cent over five years and 8.3 per cent over three years, and lost 0.5 per cent over one year.

Sector-wide performance figures are meaningless anyway, since these funds follow such varied strategies to achieve positive returns in any market conditions, so you need to examine their individual approaches before you invest, according to Jason Hollands of Tilney Bestinvest.

Sector watch: Performance of absolute return funds over five years (Source: FE Trustnet)

He advises checking the objective, which is often an excess return over cash on a three-year rolling period. Cash usually means the three-month Libor rate – the rate at which certain London-based banks are willing to lend to each other over the next quarter.

However, the excess by which a fund is trying to beat cash might vary from 3 per cent to a far more aggressive 12 per cent. And in some cases, the goal will be providing steady returns with low levels of volatility, while in others it will be more growth-oriented which implies riskier bets.

Hollands said the period given for delivering returns is also important, explaining: Absolute return funds are not guaranteed investments and dont mean youll never seen down months. The time period of positive returns targeted is usually over the medium term.

Meanwhile, Hollands said you must also look at the strategy being employed to deliver returns. This might actually mean a lot of different strategies, as with the 30-odd used by the Standard Life Global Absolute Return Strategies fund.

Also, some funds might be multi-asset, potentially making them more complicated, while others focus only on shares. One typical approach is a long short fund trading equities, perhaps specialising in UK, global, or European markets.

Funds watch: Top ranked absolute return funds based on three-year performance (Source: FE Trustnet)

Going long is the traditional method of buying shares because you believe they will go up in value. But investors who short stocks are betting on price falls. In the latter case, Hollands explained that managers will borrow shares for a period, and then sell them in the expectation that they can buy them back at a lower price just before they have to return them.

When it comes to how thoroughly you need to grasp such strategies before putting money in a fund, Hollands said: I wouldnt say you have to be a mechanic to drive a car, but its advisable to have a basic understanding of what your investment is trying to do and for you to feel confident with it.

Of the absolute return fund sector in general, he said: Its an incredibly mixed bag, with different risk-return profiles. Some have quite tight targets of returns over cash. Some have more aggressive targets. You need to look at any of these funds against its stated strategy.

Top performing funds in March: Brian Dennehy says some brave investors, probably hedge funds, put money in the Brazilian market as political turmoil gripped the the South American country .uk)

Worst performing funds in March: Absolute return funds took the six bottom spots last month (Source: .uk)

Great care must be taken when buying this nominally low risk sector, says Brian Dennehy of It is not easy to see what is driving returns and where risks are being taken, and the managers are too often not forthcoming when pressed on these issues.

He suggested that this sector should really be regarded as retail hedge funds.

Quite a number of these are very sophisticated. Its very difficult even if you are a professional to know what positions are being taken, and to know what the potential risks are as well as the potential rewards.

Dennehy described some of the strategies employed as idiosyncratic. He said you just had to trust the managers involved, although you really shouldnt have to rely on this when investing, and absolute return certainly shouldnt be regarded as a low risk sector..

He advised investors to be wary of all absolute return funds, and to do a lot of research if they want to invest in them.

Hollands said: I think they do have a role to play in a portfolio but these are not guaranteed investments. They can help make sure your portfolio is not so wholly correlated with the equity market.

In the past, he said you might have sought this kind of diversification with a bond fund, holding corporate or government bonds or both. But Hollands explained that since the financial crisis, bond markets have been heavily distorted by the quantitative easing programmes run by central banks.

Many financial expertsfear a bond crashonce central banks start to raise interest rates again, because investors could decide they overbought bonds – both government and corporate – and dump them in a hurry.

Source: Investment Association and Morningstar

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