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October 4, 2016

Are Absolute Return and Alternative UCITS Funds Delivering on their Promises?

by Detlef Glow.

The markets for equities and bonds faced increasing volatility during the first six months of 2016. In these tough market conditions a number of absolute return funds and alternative UCITS funds faced losses. The—in some cases—large drawdowns and resulting low performance numbers led to criticism by market observers, since the products claim to achieve only positive absolute returns. However, the majority of funds in the relevant Lipper peer groups define their performance targets over a long-term horizon, not over the short term.

One of the established research papers analyzing this market is the study ‘Qualitätsanalyse Absolute Return-Fonds in Deutschland’ by the German fund promoter Lupus alpha that is conducted every six months and uses Lipper data to evaluate the quality of absolute return and alternative UCITS products registered for sale in Germany. Since the study covers the performance of 567 funds (year to date), 532 funds (one-year period), 411 funds (three-year period), and 310 funds (five-year period), it gives a good overview of trends in the European fund industry.

The main finding of the study was that the majority of analyzed funds keep their promise over the five-year period; 86.2% of the funds showed positive returns for that period. Even those funds were not able to deliver only positive absolute returns; 73.0% of the funds delivered positive risk-adjusted returns, measured by the Sharpe Ratio. The analysts from Lupus alpha concluded that the number of funds with positive performance as of June 30, 2016, is in line with the numbers of previous years, while the number of funds with a positive Sharpe Ratio is down 8 percentage points (81% as of June 30, 2015). The analysts point to the fact that the results for the Sharpe Ratio vary widely; from their point of view that is a sign of a difference in the management quality of the products.

Over the three-year period 76.2% of the 411 analyzed funds showed positive returns, which was significantly lower than the 92.5% of funds with positive returns in the three-year period ending June 30, 2015. The funds showed performance of 2.83% on average over the analyzed period—a significant decrease compared to the previous period (+5.37%). The lower return numbers led, as was to be expected, to lower risk-adjusted returns. Even under these circumstances only 67.5% of the funds were able to deliver a positive Sharpe Ratio. This number was also significantly lower compared to the previous period (86.0% as of June 30, 2015). Over the five-year period the risk-adjusted returns varied widely, which again indicated high differences in the quality of fund management.

The rough market conditions during Q4 2015 and the first half of 2016 were a challenge for the managers of absolute return funds and alternative UCITS funds, reflected in the performance for the one-year period. Only 29.5% of the 532 funds analyzed over this period showed positive returns. With regard to the risk-adjusted return, only 31.3% of the analyzed funds showed positive numbers. This number was far below the number for the previous year (65%).

From my point of view the comparison of the different periods indicates that absolute return funds and alternative UCITS funds registered for sale in Germany hold their promises over the mid-term period but have struggled to cope with the rough market conditions during last quarter 2015 and the first half of 2016.

The wide variation in the returns of the different peer groups, as well as the variation in the absolute returns and risk-adjusted returns of the different peer groups, indicates that investors need to make clear asset allocation decisions in order to find the peer group that suits their needs. Once this decision is made, investors need to make a qualified assessment of the individual funds to select a manager who delivers the promised and therefore expected return. This means an in-depth quantitative and qualitative analysis of the funds is key for the success of an investment in absolute return funds and alternative UCITS funds.

The views expressed are the views of the author, not necessarily those of Lipper.

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