Absolute return funds prone to mis-selling and weak returns

FitchRatings-logoEurope's growing number of absolute return Ucits funds are liable to be missold and may disappoint investors with poor performance during a bull market, according to a report by Fitch Ratings.

The market for these funds has grown 80% since January 2009, reaching €140bn in assets under management in March of this year, said Fitch. The products aim to consistently yield positive returns in all market conditions over the medium to long term.

However, absolute return funds employ a wide variety of strategies and invest in a range of asset classes. “There is no commonly agreed, standardised definition of what effectively constitutes an absolute return fund,” said Fitch.

This means there is a risk of mis-selling to less sophisticated investors who do not realise the term absolute return describes a multiplicity of differing funds.

There is also confusion as to what absolute return funds offer. Investors cannot expect hedge fund-like returns because absolute return Ucits products are regulated and cannot invest in illiquid assets or employ large amounts of leverage.

Another problem is that absolute return funds are likely to perform comparatively poorly in periods when the markets are doing well. This is because these funds invest significant sums in downside protection, for instance dynamic hedging and frequent use of stop-losses, at the expense of beta strategies that generate returns when the market goes up.

“Post-Lehman, absolute return funds have become far more focused on risk management and liquidity mismatch reduction, in line with investor expectations,” said Fitch. “This focus may restrict funds from capturing market upside, resulting in modest returns.”

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