February 2011

ABSOLUTE RETURNS: what's in a name?

shakespeare_roseAbsolute return funds are hard to classify and the grouping of such products should be discouraged or reconsidered, says Angele Spiteri Paris “What’s in a name?” asked Juliet Capulet in Shakespeare’s famous play. Were she looking at the universe of absolute return funds, she may have come up with the same conclusion she did then – that a name doesn’t actually amount to much. Absolute return is a very broad church and, therefore, funds with very different strategies are often bunged into the same group, simply because of their name. And this practice could have some very negative repercussions. The UK’s Investment Management Association (IMA) is an organisation that created one such absolute return group. It clearly states that the performance data should not be used for comparative reasons. Jane Lowe, the IMA’s director for markets, says: “Performance comparisons should not be made because the sector is still immature and the funds have diverse characteristics.” Regardless of this warning, the likelihood is that seeing funds being placed in one universe, investors, particularly those who are less financially educated, will compare these funds to one another. Michael Warren, investment director at Thames River Capital, part of the F&C group, says: “I think people do compare them and they mostly compare them to the average fund, which is not the right thing to do.” One of the most significant dangers in comparing the funds’ performance within an absolute return universe is that all the funds in any of these groups differ greatly in asset class, strategy and investment process. This makes any comparison completely meaningless. Cedric Bucher, director of client investment strategy, SEI, says: “The peer group comparison is not very meaningful since it consists of a very diverse number of managers and strategies. Paul Moody, global head of investment development, Aviva Investors, says: “I don’t think a peer group comparison makes sense because absolute return is not a homogenous group at all.” Sub-categories
One solution to making an absolute return universe more meaningful would be to introduce sub-categories according to asset class or investment process. “I don’t rule out the possibility that changes may be made to the absolute return universe following the  sector review,” says Lowe. Warren says: “There are some thoughts that there will be sub-sectors created within the absolute return universe. This would help because at the moment you have credit, government bonds, long/short equity funds in the universe, which all have very different return profiles.” And, naturally, the differing goals of each absolute return fund makes it difficult to think of them as a group. Some funds promise a positive return over twelve months, while others aim for good performance over a three-year period, although the wording in several of these funds’ factsheets does not always make this objective clear. Several of these marketing documents say the objective of the fund is to produce positive returns over a market cycle. So performance, or at least how it’s perceived, largely depends on that manager’s definition of a market cycle. Warren, at Thames River, says, “For some, a market cycle is five years, while others aim to make money year in, year out. The way people explain their funds needs to be looked at.” Therefore, the way managers communicate with their clients can be vital for the perception of absolute return funds and the way they perform. In fact, the labelling side of the fund business is often targeted as being part of the problem. The absolute return label has been bandied around with too much gusto in the past, leaving investors disappointed. Marketing spiel
Edouard Carmignac, chairman and chief executive of Carmignac Gestion, says: “People realised that the absolute return tag was a good marketing tool and in fact, several of the absolute return funds created in 2003 and 2004 went on to crash in 2008 and 2009.” “Absolute return became a fad and everyone began using the brand ‘absolute return’ when really, not all of those funds were actually exercising absolute return strategies,” Bucher says. Meanwhile, Robert Howie, principal, at Mercer’s investment consulting business, says: “There have been times when a strategy labelled as absolute return has not lined up with that name. “If the absolute return tag is more of a marketing device rather than a description of the product’s investment strategy, it reflects badly on that particular manager.” This issue of product names has come to the attention of the Financial Services Authority in the UK. Reportedly, the FSA raised concerns about the absolute return tag and is said to be asking managers to steer clear of using these words in the names of new products. Moody, at Aviva Investors, says: “The approach to marketing these absolute return products needs to evolve. We’ve always looked to highlighting the risk associated with each strategy and product in our range.” Ed Moisson is head of UK and cross-border research at Lipper. “Even if the FSA does implement new rules on the way these funds are labeled, the concepts behind the way they are being managed will not go away,” he says. Rather than changing the label, it’s more a matter of explaining the way the fund is managed and making the objective and the return horizon crystal clear. It is the job of consultants like Mercer to get under the bonnet and find out what really goes on within each fund in the so-called absolute return universe. Howie says: “Our job is to look beyond the label and really understand exactly what the strategy does. Working through the jargon and terminology is sometimes difficult.” Shared characteristics
But, despite the vast disparity among the absolute return funds out there, these funds should share one characteristic – they generally should seek to produce returns in spite of market performance. Moody, at Aviva Investors, says:  “The one thing absolute return funds should have in common is that they’re trying to generate a real return regardless of market direction.” Unfortunately, this does not always happen. Olaf John, head of Europe distribution at Insight Investment, says: “In December 2008, many absolute return strategies turned out to be beta strategies even though they had been created as an alpha play.” Bucher, at SEI, explained this further. “There are some products called absolute return, which have seen 15% return in an up market and have been down in falling markets. In these cases, there is clear correlation to markets,” he says. “Many absolute return funds have an element of market correlation. Some market correlation can be tolerated, but if that correlation is significant, you’re definitely stretching the definition of absolute return,” adds Howie. Equity bias
The fact that a significant number of funds in the IMA universe performed in line with markets has been attributed to the fact that the UK universe is very equity biased and long/short equity absolute return funds tend to have more market correlation. The preference for absolute return funds based on equities seems peculiar to some market experts. Several observers have come to the consensus that fixed income is better suited to generating absolute returns and with equity-based funds, achieving a pure absolute return is more challenging. John, at Insight, says: “Fixed income is well-suited to the absolute return approach. The starting point, the benchmark, is cash, which is a fixed income benchmark [because most funds’ goal is to achieve a percentage return over Libor or Euribor – the overnight inter-bank offer rates].” Stefane Fertat, fixed income portfolio specialist at T Rowe Price, says: “We believe that fixed income is better suited for an absolute return approach. The variety of opportunities, whether it is currencies, duration, curve, countries, corporate bonds, as well as the variety of derivative instruments available to express negative or positive views, argues in favour of a fixed income product where relative value opportunities are captured.” The way forward
The equity bias in the UK is largely due to the dominance of the BlackRock Absolute Alpha Fund, which is a long/short equity product and is one of the biggest funds in the IMA universe. However, some experts believe this is bound to change, as Gavin Ralston, global head of product at Schroders, points out. “Funds in the UK will become broader in their approach to seeking absolute return and this will reduce the equity market correlation. The proportion of absolute return funds that use equity as their investment engine will reduce,” he says. So, to level out the absolute returns in the UK and move away from generating correlated performance, the market needs to see the creation of new funds – new funds with a fixed income or currency base, not an equity one. Ralston believes investor demand in the fixed income absolute return space will push managers to bring more such products to market. “The demand for absolute return is very strong and managers will respond to this and begin using a broader investment approach. It’s more difficult to use equities to deliver absolute returns consistently, and most investors realise that,” Ralston says. In fact, Schroders is looking to service this  anticipated greater demand for absolute return by launching more funds in the space. One of the new products due to be brought to market is a currency absolute return fund. This is due out in the first half of the year. John, at Insight, says: “There are huge opportunities in the market for fixed income and absolute return funds due to the decline in equity investments. “In the institutional space, this is driven by new or additional regulation and private investors focus increasingly on capital protection.”  

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