Absolutely inconsistent funds

LUTE

LUTE return funds aim to deliver positive returns – even in falling markets. Unlike other fund sectors, which are defined by the assets they hold, absolute return is defined by its performance.

The sector has £24.7bn of funds under management, about 4 per cent of the retail fund market. However, some experts are concerned that they do not deliver value to investors. They can be tricky, and should not be entered into without proper research.

Last year, only a third of these funds delivered a positive return, leading consumer group Which? to call absolute return an “unlucky financial product”. Jason Hollands of Bestinvest says that “many have not delivered on their promise of absolute return”. Patrick Connolly of AWD Chase de Vere thinks that the label can be misleading, and could give “a false impression that performance does not justify”. Investment Management Association (IMA) director Jane Lowe explains that the definition “is not ideal,” since it was given when the sector was young and only a few funds existed.

Deciding whether the fund is right for you requires a look at where there are gaps in your portfolio. Often, investors feel obligated to add the fund without having sufficient justification.

BENEATH THE SURFACE
If you are considering investing in these funds, their ambiguous definition requires a careful look beneath the surface to see how each fund works. Christopher Traulsen, director at Morningstar, explains: “Absolute return funds take different risks in different sectors over different timeframes – the only thing that the funds have in common is that they try not to lose money.”

Morningstar has split the sector into 18 sub-sectors, with each fund described by their objective and risk characteristics. The top 10 performing funds over the last three years span seven different categories, highlighting the variation in their strategies.

According to Morningstar, the top-performing fund over the last three years is the Absolute Insight Credit B1p GBP fund. It returned 56 per cent using a debt arbitrage strategy, which aims to take advantage of differences in the price of debt securities. In contrast, Odey’s UK Absolute Return fund, which is ranked second, uses a long/short equities strategy, allowing the fund to profit when the stock market goes up or down. It has returned 50 per cent over the last three years. The rest of the top 10 is made up of other strategies including: multi-strategy funds, which use a variety of approaches; flexible allocation funds; cautious allocations; market neutral funds, which use hedging techniques to avoid specific market risks; and fund of funds, which invest in other types of funds.

SEEKING ABSOLUTION
Absolute return funds are difficult to compare, since they use different benchmarks to evaluate their performance: some seek to outperform Libor, others look to outperform equity indices.

The absolute return sector is complex. Sophisticated, often institutional investors have traditionally sought the strategies that they employ. The safest strategy for investors is to adopt a “super selective approach,” according to Hollands, since many funds have short track records.

Most retail investors will have more than sufficient diversification through their holdings in cash, equities, fixed income and property. The sector is more appropriate for those who have large portfolios and are seeking to add another level of diversification.

However, due to the differences in the types of funds, all investors should look under the surface of each fund to check whether it would be an appropriate addition. Discover whether it is doing what it says on the tin.