EUROPE - Scepticism some European allocators feel about the ability of ‘absolute return' funds to achieve their aims has been vindicated so far this month as almost eight in every 10 European funds in the sector lost money in the volatile first three weeks.
The 2.5% average loss from European absolute return funds by 19 August was far less severe than double-digit falls seen on some European share markets.
But it still raises questions about whether the fund sector is living up to its name. Fitch used a report on the sector it published today to suggest, at least this month, it is not, and to predict fund closures as a result.
On the investment goal Fitch suggested for absolute return - "positive returns in all market environments" - 79% of funds fell short this month, and the sector has lost 3.5% on its clients' investments this year.
Some 77% of AR funds are down this year, and 85% have underperformed fairly meagre cash returns. "Negative total returns reflect particularly badly on AR funds, which aim to outperform cash returns," said Fitch.
Another sector - hedge funds - whose name investors might query this month, have lost 4.1%, according to a limited set of investable hedge funds in the HFRX Global index, published by Hedge Fund Research.
The benchmark is down 6.2% this year.
During the latest bout of volatility and sharp market declines, John O'Toole, overseer of €30bn of client money as head of multi-asset portfolio management at Pioneer Investments, said: "What would help me hugely would be to find more absolute return managers that actually achieve absolute returns."
Data on the sector's performance so far this month, revealed in a Fitch report published today, suggested finding them in August was rare.
Managers were not defensive enough coming into the month, Fitch said, possibly because risk budgets were too high and cash holdings too low; maybe because managers "lacked the ability to adapt to fast-changing market circumstances during the holiday period"; or macro-overlay or tail-risk option hedging was insufficient, non-existent or failed to work; or because any relative-value trades or short positions were not strong enough a hedge.
The ratings agency called August's sell-off "the clearest test since the Lehman fallout of the ability of absolute return and multi-asset flexible funds to achieve their objectives.
"Not all first quartile European AR funds have managed to preserve capital year-to-date. The widespread negative performance of August has amplified the negative returns which already existed at the end of July," Fitch added.
It said repairing losses over the medium to long term, in line with investors' expectations, will prove "a major challenge" for asset managers and may encourage higher risk-taking and potential of moves into new asset classes to do so.
"The August ‘performance test' revealed many losing, and a few winning, funds. As a result, as was the case after the 2008 market collapse, investors should increasingly discriminate between funds based on their performance.
"The worst performers are likely to be driven out of the market, as investors discriminate based on performance.
"The few funds that successfully passed the August test should therefore benefit from new inflows, and those that failed should suffer from outflows. Managing substantial subscriptions and redemptions without distorting performance may prove another challenge for asset managers in difficult market conditions."
Investors in absolute return funds might find some consolation in the fact flexible funds, one alternative sector whose goal is to provide "asymmetric returns relative to a balanced bond and equity allocation via changing market risk exposures", fell 7.6% by 19 August. They are down 8.9% this year.
Typically long-biased, flexible funds managed to avoid 70% of the August market declines, on average, and half of the portfolios have outperformed a balanced bond and equity allocation so far this year, Fitch noted.
This article first appeared in GP sister title Investment Europe
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