July 15, 2011 5:56 pm

Mis-selling warning issued on absolute return funds

Absolute return funds are increasingly at risk of being mis-sold to private investors who are seeking a safe haven for their cash, according to an alert published this week.

Investors who have bought an absolute return fund may not realise that their cash is not guaranteed, Fitch Ratings has warned.

The agency said that “less sophisticated” investors were also at risk of being disappointed with fund performance, as absolute return funds focus on protecting investors from any downside rather than trying to outperform the market.

Sales of absolute return funds have rocketed in recent years as retail investors seek a safer haven for their investments in the aftermath of the financial crisis. They usually aim to provide positive returns in any market conditions on a 12-month basis.

The European absolute return market, including UK funds, has grown 80 per cent since the end of 2009, according to the Fitch report.

However, financial advisers have warned that many absolute return funds are not providing an absolute return in all types of market.

“People are buying absolute return funds without understanding what they are,” said Patrick Connolly at AWD Chase de Vere, the financial advisers. “They think they will go up in all environments and that’s not the case. The products have been bought more on perception than reality.”

Research by Lipper found that nearly a quarter of UK absolute return funds had lost money over annualised periods in the past four years. Some funds had lost more than 10 per cent in a 12-month period.

Analysts at Fitch said that investors needed to realise that absolute return products might be volatile over shorter time periods and that the name “absolute return” did not provide any guarantee that cash would be returned.

The report also said that absolute return funds have become more focused on risk management since the financial crisis, which may restrict them from capturing any rise in the markets – resulting in modest returns at best.

“The name is simply wrong,” said Tom Becket, chief investment officer at PSigma.

“Many funds have suffered material drawdowns in times of market stress and others have acted simply as ‘watered down’ equity market beta.

“Fund management houses have been poor at detailing the risks of such funds and investors have not examined the possible risks involved with such funds. Furthermore, due to the widespread use of leverage and derivatives within the funds, I would also question the suitability of such funds for private retail investors.”

Absolute return funds have been criticised for their hedge fund-style charges, as well. Most levy performance fees when they outperform a benchmark, plus high annual charges.

“The sector hasn’t shot the lights out,” said Meera Patel, senior analyst at Hargreaves Lansdown. “A lot of these funds haven’t really delivered and I don’t understand how they can justify charging a performance fee.”

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