Do absolute returns promise too much?

Posted on: 07 September 2011 by Peter Meeson

Peter Meeson explains 'absolute returns' and what bearing they have on your pension fund, investments or ISAs

absolute returnsAs we mentioned in this column a few weeks back, an investor subjected to the FTSE100 over the last eleven years would still have lost money on their original investment. This is primarily for investors who didn’t actively manage their money – and that is probably the vast majority of investors.
When we say ‘manage’, we mean to move capital around and decide which are the best stocks and geographical areas to invest rather than simply investing and leaving your capital to meander, ferment, or just corrode. Sound familiar?
Most investments are subjected to the latter and the investment industry has reacted by introducing the ‘absolute returns’ sector. This sector aims to produce a positive return on your investment, whether or not the market is going up or down, or alternatively, to produce a pre-defined return over a straightforward cash account. That’s the theory.
In practise there is a substantial gap. And if you believe one absolute returns fund is the same as the next you will be comparing apples with chairs.

The whole point of an absolute return fund is to provide a varying approach to the normal portfolio of investments you have. On closer inspection, however, most funds in the sector behave in much the same way as a normal run of the mill managed fund, thereby offering you little or no diversification.
Over the last twelve months the FTSE100 has risen 5.95% (1), so an absolute return might be expected to produce a return in excess of that. But of the 63 absolute return funds, only fifteen managed to outperform the FTSE, with eighteen producing a return less than zero. (2)

It’s perhaps a little poetic of us to talk about absolute return funds in this way, in that they really are like comparing lobsters and chickens. The unsuspecting investor unaware of this could find themselves in a stew of low performance and higher charges, or in other words, find themselves caught between a rock and a hard place.

Performance fees are normal at around 20% if the fund performs above and beyond an agreed target, which is often unexciting. This fee is on top of the annual management fee of c1.5%.(3) Many moons ago performance fees were introduced for an exceptional reward for an exceptional return, not any more.
As for risk, well, that's another story. The highest risk fund over the last twelve months behaves significantly differently from the lowest risk absolute returns fund (Aegon UK Equity absolute return). In pursuit of its gain, it is actually twenty one times more risky than the Aegon fund – I won't mention its name but Occam is a clue. (4)

Those of you already bewildered by the complexity of these funds will probably find it beneficial to seek investment advice, as the workings of this investment product are beyond the comprehension of most advisers. Speak to an adviser who can see through the 'noise'. Suffice to say the better funds provide a better return for the risk they take, and for a fairer fee.

Pick of our bunch for fair charges and returns over a target are CF Octopus (34.2% over the last three years), Newton real return (33.8%), Insight Absolute insight (22%) and Standard Life global absolute return strategies (25%).(2)

You may be wondering how a fund can target to produce positive returns in difficult or falling markets. The answer is that these funds have the ability to take all sorts of strategies with your money and can go ‘long’ or ‘short’ on the market, for example.

To simplify, if a manager thought the market would fall, they would effectively bet on that happening via a complex financial instrument, such as a contracts for difference and if the market did fall, the ‘bet’ would pay out to the manager. Going long is simply the opposite – betting on it rising.

So whilst three synonyms for absolute are complete, utter and unqualified, another is supreme. Picking the best funds is the tricky bit though.

For a complimentary review of your investments, ISAs or pensions call Worldwide on 0845 230 9876, e-mail or take a look at our website
The values of shares and investments can go down as well as up.
1 google finance
2 trustnet
3 sesame research
4 Lipper

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