Monday Morning Memo: Diversity within Absolute Return Funds

Lipper’s Jake Moeller examines the considerable compositional diversity of funds that have an absolute return mandate.

Deciding what constitutes an “absolute return” fund can be fraught with difficulty. Typically, groups of funds can be classified by common underlying assets; however, where we define a fund by its strategy things stray into a greyer area.

Reuters/ Tobias Schwarz

The U.K.’s IMA Association admirably redefined and renamed the Targeted Absolute Return Sector in 2013; it now simply states they are funds “managed with the aim of delivering positive returns in any market conditions.” However, that is then qualified with seven footnotes. Lipper defines absolute return as being those funds with that stated aim in their prospectus. Recognising as does the IMA the broad church this creates, Lipper introduces a value-at-risk measure to try to create homogenous groups. Such qualification and methodology appears necessary; these funds form a heterogeneous group of products that could possibly deceive investors through the simplicity of absolute return in the nomenclature.

Absolute return as an investment concept is increasing in popularity. According to Lipper FundFile data, for the year to date to the end of May 2014, €21 billion of net sales has flowed into funds with absolute return characteristics within Europe (including the U.K.). The calendar year 2013 saw €51 billion of net sales, a figure which was more than double that of the flows for 2012 (€23 billion). By comparison, for 2009 a mere €16 billion flowed into such funds. Investors, advisors, and fund managers, all of whom have been affected by the trauma of 2008, are now much more familiar with concepts such as “draw down” and “maximum loss,” and they increasingly eschew relative return benchmarking, irrespective of risk profile.

A review of Table 1 reveals just how broad the absolute return church is; within the IMA Targeted Absolute Return Sector alone, there are 17 differing Lipper Global Classifications, ranging from global bonds to U.K. equities.

Table 1. Lipper Global Classifications Within the IMA Targeted Absolute Returns Sector.

Source: Lipper

There are therefore extreme variations of asset composition, with some funds in the sector containing over 90% equities while others are composed mainly of fixed income securities and cash. And the clue isn’t always in the name; for example, Jupiter Absolute Return Fund is heavy cash, Odey Absolute Return Fund is mainly equities and Way Absolute Return Portfolio Fund is a fund of hedge funds. The diversity of funds that purport to have an absolute return mandate is better illustrated through analysis of the risk/ return outcomes:

Table 2. Three-Year Risk/ Return Profile of a Selection of Funds within the IMA Targeted Absolute Return Sector

Source: Lipper for Investment Management.

The examination of funds with absolute return characteristics requires much more science than is applied here, but there are some key conclusions for investors: Absolute return doesn’t mean relative risk is eliminated; sector classification, although valuable, is an imprecise science; and fund houses are increasingly canny in how they seek to classify their funds (or are indifferent to rigorous classification at all). When you throw into the mix the development of more sophisticated asset allocation models and higher use of complex instruments within portfolios, you have a cloud that is very hard to catch and pin down.

In the recent Lipper review of Jupiter Absolute Return Fund, which sits in the IMA Targeted Absolute Return Sector, fund manager James Clunie recognises the difficulties around sector composition. He suggests investors seeking absolute-return solutions look closely at “where the manager has an edge,” and not just choose a fund on its short-term track record, its sector classification, or its name.