Time to sort out the apples and pears

A dramatic expansion of the IMA Absolute Return sector has laid bare the disparate nature of funds under its banner. AFI panellists are supportive of initiatives to reform the peer group.


The Absolute Return sector faces growing scrutiny as it nears its third anniversary. At its launch in April 2008 it contained just 17 onshore and offshore funds. That number has tripled, according to data from Financial Express, leading to concerns over the labelling of such products and the usefulness of grouping many diverse strategies under one banner.

The Investment Management Association (IMA) launched the sector in response to rising appetite for funds which, according to its definition, aimed to deliver “more than zero returns in each year”. The steady returns of Mark Lyttleton’s BlackRock UK Absolute Alpha portfolio had proved particularly popular with retail investors, encouraging managers to bring more absolute return products to the market.

But as the number of absolute return funds rose dramatically in 2008 and 2009, the disparate nature of their strategies became apparent. While BlackRock UK Absolute Alpha and Cazenove UK Absolute Target sought to grind out regular ­market neutral returns through pairs trading, other funds in the sector were taking directional bets.

The most dramatic example was CF Octopus Absolute UK Equity. The fund, which once boasted daily inflows of £1m, achieved stellar performance by shorting equities and then reversing the position as stockmarkets began rallying in early 2009. The fund returned about 60% in the first 10 months of that year, compared with a sector average of under 10%. Over the next few months, however, incorrect calls on market direction and mining stocks caused it to fall sharply in value. (article continues below)

Other funds in the sector have posted smaller declines, prompting concern from the Financial Services Authority (FSA) that the “absolute return” tag may be misleading some investors. The regulator is reportedly advising firms not to use the label when launching new products, and last week published a discussion paper on toughening its “interventionist” approach.

“We will now intervene earlier in the product value chain, proactively, to anticipate consumer detriment where possible and stop it before it occurs,” the FSA wrote. “We are look­ing in more detail at how firms design products and their ongoing governance procedures to ensure that products function as intended and reach the right customers.”

Neither Toone nor Willis favours the proposed time-frame method for sub-dividing the sector, however. Toone says he would prefer a system which distinguishes between “more speculative” and lower volatility products. He favours funds at the cautious end of the scale and uses BlackRock UK Absolute Alpha within the AFI. Outside the AFI, he holds Insight’s Absolute UK Equity Market Neutral and Currency funds, and Standard Life Global Absolute Return Strategies (Gars).

Toone is nervous about Gars’ recent underperformance but Willis, who added the fund to his Cautious AFI selections in November, is confident it will recover. Elsewhere in the indices, Willis ejected CF Odey UK Absolute Return – despite its “excellent” performance in rising markets – and also removed Cazenove UK Absolute Target and BlackRock UK Absolute Alpha, in response to poor conditions for market neutral strategies.

Willis’s rebalancing decisions led to the ejection of the Cazenove and Odey portfolios from the AFI in November. Baring Absolute Return Global Bond, Gartmore European Absolute Return and Insight Absolute Credit were deselected by other panellists, leading to their removal from the benchmark series (see table).

Standard Life Gars remains popular in the AFI, with 12 adviser selections across the three indices.

________________________

The Adviser Fund Index series comprises an Aggressive, Balanced and Cautious index each tracking the performance of portfolio recommendations from a panel of 18 investment advisers. For each risk profile, all panellists specify a weighted portfolio of up to 10 funds from the authorised UK unit trust and Oeic universe that, when aggregated, define the constituents and weightings of the three AFIs (see www.fundstrategy.co.uk/afi/).