Time for a rethink on poor performing Absolute Return funds

It has been a decade since Lehman Brothers collapsed, sending shockwaves through the global financial markets and the “real” economy too.

Part of the response was a dramatic cut by the Bank of England in interest rates from 5% to 0.25% in just a few months, effectively wiping out bank deposits as a source of safe and reliable income for savers.  

Ten years on this is still the case, with bank accounts guaranteed to lose money, with a loss of £1,920 in real terms for every £10,000 of savings over the past decade.

A punishing time for UK savers and investors – many of whom want, not unreasonably, a relatively safe place where they will get a modest rate of return in all markets combined with reasonably easy access.

Our research shows that millions of people are seeking investments offering inflation-beating stable returns above 3%.  This is exactly what Absolute Return Funds (ARFs) should be delivering.

According to the Investment Association, the market for Absolute Return Funds is the third biggest amongst investment sectors, larger than the GBP Corporate Bond Market. Over the past 18 months the amount invested in ARF’s has grown from £70.50 bn to £81.10 bn, with the aim to “generate a positive return in all market conditions”, giving further evidence that there is a huge need for a reliable investment paying out returns with moderate to low volatility.

Take a closer look, however, and sadly you’ll uncover a market that is not delivering on its targets.  High charges and investment strategies which are often very complex, have often not delivered the target return, with many funds failing to achieve positive returns, despite a continuing bull market. The problem is compounded by high management fees and performance fees which makes matters worse.

BondMason analysis shows that over the last 3 years, 71 out of the 97 Absolute Return Funds in the UK delivered a positive gross return, but the management fees wiped this out.   Only 26 funds returned positive net returns (post fees), averaging just 1.59%  which is dire, considering how much money has been committed to them.

The problems facing AR funds is highlighted by the news this week that the Standard Life Global Absolute Returns Strategy (Gars) fund that once was a flagship of the sector will have an estimated £12bn outflow this year.  We expect to see other AR funds experiencing investor flight as poor performance hits home with investors and advisors.

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We have identified three key factors afflicting Absolute Return Funds.

  1. Fees are skewed towards fixed management fees – payable in all market conditions, creating a drag on performance, and don’t align the interests of managers and investors, or incentivise managers to improve performance.
  2. Lack of transparency makes it harder for advisers to conduct adequate due-diligence on a product. Added to that, the complexity and opacity makes it harder for investment teams to explain their strategy.
  3. Bigger isn’t necessarily better. Our analysis shows that there is no statistically significant correlation between good performance and size of fund in the Absolute Return market, with the best performer, JPM Global Macro, being the 20th biggest fund.

The complex nature of these funds also means they are particularly vulnerable to a manager exit, with replacement managers being unlikely to be able to replicate the strategy.

For investors, the challenge of selecting a good fund is made harder by varied performance objectives and strategies and a wide range of charges and fee structures, all of which makes it very difficult for investors to compare performance.  

Uncertain times and the need for simplicity

It is hard to argue that the past three years have been anything other than colourful in terms of world events.  We’ve seen polarisation arising from the Brexit vote, Trump’s roller coaster presidency, Russian aggression, China-US trade war, numerous wars in the Middle East, and the price of oil see-sawing.  This helps to explain the continued rise in popularity of Absolute Return Funds, but their under-performance means investors are losing out. 

By contrast, other types of investment, with more simple strategies, continue to be popular and perform well within a diversified portfolio. Mutual funds, ETFs and fixed term bonds to name a few.  Interestingly, our research shows that investing in property continues to be regarded as a good way to earn decent returns.  However, with the advent of new tax and mortgage regulations, accessing returns from buy-to-let and direct property investing is harder than it once was.  There are alternative ways to earn a passive income from property, with attractive risk-adjusted returns, including property-backed lending. As with all investments, it’s important to conduct due diligence to ensure the investment meets your objectives, capacity for loss and time horizon.

2019 is promising to be another uncertain and challenging economic period. Investors will be keen to replace their ARF strategy with something that promises to be more robust. We expect to see inflows into alternatives including illiquid assets and property lending as a method to keep investment portfolios above water.

Stephen Findlay is the CEO and founder of BondMason (www.bondmason.com ), the investment specialists. He is a Fellow of the Institute of Chartered Accountants in England and Wales.

BondMason enables investors to achieve attractive risk-adjusted returns from direct lending. The experienced investment team sources and filters secured lending opportunities, with a focus on property-backed lending; reviewing lending partners and loan opportunities using rigorous selection criteria before approving 1-in-4 loans for investment.  Our clients have achieved an average gross return of 8% per annum since 2015, from a conservative and diversified portfolio of loans.

About the research

BondMason’s research was conducted in August 2018 by accredited market research agency DRG who interviewed a sample of 1,014 UK adults with at least £25,000 in money or investments (including, if they have them, a private pension fund and second property).

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