May 2010

ABSOLUTE RETURN: smooth operators

With the market plateauing, a number of managers are investing in absolute return funds, which promise more stable returns. But providers should be more transparent about performance fees, finds Angele Spiteri Paris PlastererAbsolute return funds are not a new phenomenon by any means, but interest in this approach waxes and wanes according to market performance. Many new funds were brought to market in recent months, as the relief rally of the latter part of 2009 began to die down. But the debate about performance fees rages on.

According to Lipper FMI, 88 absolute return funds were launched between September 2009 and the end of February this year. Of these, 45 are cross-border funds while France, Italy and the UK each saw nine launches.

Legal & General Investment Management, Gartmore, Liontrust and Deutsche Bank are  some of the fund management houses that have launched, or are about to launch, these funds.

Ian Heslop, head of quantitative strategies at Old Mutual Asset Management (Omam), says: “The timing of the launches is down to the luck of the gods, although it was very positive that these funds hit the headlines during a period of lower equity market returns.”

Omam was due to launch the Old Mutual UK Specialist Absolute Return fund in May this year, but has since delayed the launch.

Bill Maldonado, head of alternatives at Halbis, part of HSBC Global Asset Management, says: “It’s somewhat coincidental that a concentration of absolute return funds have been launched within the same time frame.”

But not everyone thinks the timing of the launches is down to fate. Some believe these funds were brought to market in reaction to the recent economic environment.

Madeline Forrester, head of global institutional business at fund manager Threadneedle, says: “It’s not a coincidence that a number of absolute return funds came to market at the same time. There has been continued demand from investors for a range of absolute return products and we will continue to see this demand.”

Euan Munro, head of multi-asset investing and fixed income at Standard Life Investments, says: “There may be an element of opportunism in the degree at which fund managers
are launching these funds. After all, the customers are interested and they are buying these products.”

Standard Life Investment’s Global Absolute Return Strategies Fund was launched in 2006, while Threadneedle’s most recent absolute return offering was its Credit Opportunities Fund, brought to market last May. The firm is also reportedly in the early stages of developing a new Ucits III long/short US equity fund.

Maldonado, of Halbis, says: “Interest in these funds tends to come and go, depending on the markets. When markets are going up, there’s a drop-off in interest, while there is more interest when the markets are on their way down.”

So now that markets are hitting more of a plateau, absolute return strategies are able to prove their worth.

Heslop, of Omam, says: “It’s a fair point to say that absolute return looks better now that the environment has moved from a broad rally to more of a stock pickers’ market. Before, it was more about what sectors you were invested in rather than which stocks. So the current environment plays to the strengths of a good absolute return vehicle.”

Munro, of Standard Life, says: “The trouble is, if you didn’t have this capability before the opportunity presented itself, then you don’t really know how your fund is going to perform in falling markets. Strategies that have been around long enough to have survived the market upheavals can prove that they preserved capital and maintained liquidity throughout very difficult times.”

Forrester, of Threadneedle, says: “A long track record in managing this type of fund is important. Investors are now very aware of what they’re investing in and are asking all the right questions.”

Alan Orchard, director of investment solutions at RBC Wealth Management, says: “The new products that have appeared recently are interesting and it’s good that there is now more choice in selecting absolute return funds. As we always use managers who have proven rather than back tested track records, we're watching the new funds closely to see how they develop.”

One of the main bones of contention investors have had with absolute return funds is their use of performance fees. The argument for and against this type of fee structure rages on.

According to Maldonado at Halbis: “An absolute return performance fee is a driver for remuneration.” He says such a structure encourages performance.

A common line given to vindicate performance fees is that they help align the manager’s interests with those of the clients.

Paul Moody, client investment director at Aviva Investors, says: “With a performance fee structure, manager interest is more aligned to that of the client. Although there certainly is a need for managers to be more transparent in the way they calculate the performance fees.”

But Dan Mannix, head of business development at RWC Partners, says: “Alignment of interests is an easy answer to give in defence of performance fees, but it’s only correct to a certain extent. There have been instances where fund managers have taken on too much risk driven by performance fees.”

Munro says: “A performance fee can sometimes cause problems because often it works to the benefit of the manager. Fund managers can afford to take on a lot more risk. If that risk pays off then they make a lot more money but if it goes awry then any capital losses are suffered by the fund, and therefore the clients, and not by them.”

Standard Life charges a flat fee for its Global Absolute Return Strategies fund, although Munro does concede that it is one of the more expensive strategies that Standard Life Investments offer.

According to Munro: “The alignment of interests with our clients comes from the fact that a large portion of the Standard Life pension fund is invested in our absolute return strategy. We trust our own money in it and it shows we’re massively committed to the investment process. This is better proof of alignment of interests than any performance fee.”

This does not mean that there aren’t any issues with charging flat fees on these funds. Mannix says: “Although people complain about performance fees, they seem to be doing so less and less. If you charge a flat fee, then the incentive is to gather assets. A fund manager compensated through performance fees is incentivised to make his client money.”

Moody, of Aviva Investors, says: “Although this may be true, it is easier to gather assets if your fund is performing, rather than if it is not.”

Forrester says Threadneedle offers clients the option of having either a flat fee or a performance fee structure, depending on what the client is after. She says: “We think both have their merits. There is a broad spectrum of risk across the whole absolute return range and therefore the riskier the strategy the stronger the argument for a performance fee structure.

“The debate on performance fees is more complex than just a for-and-against argument. Managers have to make sure the fee structure is designed to experience pain if the strategy does not perform and doesn’t encourage a fund manager to take more risk than is appropriate.”

Client demand
The launches in the absolute return space have also been largely driven by client appetite for this approach.

James Harries, fund manager of the BNY Mellon Global Real Return Fund, says: “The events of 2008 were somewhat of a wake-up call for investors and shook them into considering whether they can withstand losses. This has produced a spate of absolute return fund launches to address this need.”

BNY Mellon itself has seen the potential in expanding its absolute return offering. The BNY Mellon Global Real Return Fund, launched in March 2010, is the European version of the Newton Real Return Fund, launched in 1993.

Mike Faulkner, CEO of consultancy P-Solve, says: “Now is a good time to buy into an absolute return strategy. It wouldn’t have been a great idea to do so in the beginning of 2009 because you had junk running and markets were rallying and therefore it was very difficult for managers to outperform.”

One of the main selling points of absolute return funds is that they promise stable returns, regardless of market performance. This was a promise such funds have largely fulfilled, historically, the providers say.

In view of this, Harries, of Newton, says: “Investors need to be aware that not all is rosy in the fundamentals of the developed world economy and they should not expect the optimism we are currently seeing around the economy and equity markets to continue.” Absolute return investing gives fund managers more free reign, but one can question whether an unconstrained approach could give fund managers too much freedom.

Mannix, at RWC Partners, says: “The concern about the flexibility Ucits III allows fund managers is valid but ultimately it comes down to the transparency fund managers provide. At the end of the day, investors must be able to trust the corporate governance of the fund management company in which they are investing.”

©2010 funds europe

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