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August 13, 2010 6:03 pm

Investors misled on risk and return

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Wealth managers have warned that some funds in the “Cautious Managed” and “Absolute Return” sectors are not delivering the returns that investors expect.

Some funds have misleading names, while others are taking more risk than they should, advisers said.

The Investment Management Association (IMA), which represents UK fund managers, this week launched a review into the way it classifies funds to make them easier for people to understand.

The IMA groups investment funds into sectors according to strict definitions of what they can and cannot invest in. However, not all funds meet these definitions.

Funds in the Cautious Managed sector, which were the most heavily bought by private investors in June, should have no more than 60 per cent in equities. But their equity holdings actually range between 10 and 70 per cent – with nine funds breaching the 60 per cent limit.

Advisers also said the names of funds are misleading. “Both those words – cautious and managed – normally give clients quite a nice warm feeling but if you look under the bonnet you have a huge differentiation in risk,” warned Chris Andrew, director of Clarmond Advisors.

The IMA said that fund groups were meant to adhere to the sector definitions at all times and, if they did not, they were given time to make changes.

“We try to make sure the sector names are reflective of what’s going on in the sectors and are quite open to changing the names if need be,” said Jane Lowe, director of markets at the IMA.

The IMA is also looking at Absolute Return funds, which can take both long and short-selling positions in equities. These funds have sprung up in recent years in response to investor demand for funds that can provide a positive return in all market conditions, with low volatility.

But funds in the Absolute Return sector also vary widely.

“I don’t think investors have grasped that these aren’t guaranteed return funds,” warned Meera Patel of advice firm Hargreaves Lansdown. “The underlying funds are massively different with different performance targets.”

Some Absolute Return funds are equity-based, for example, while others invest in bonds. Some focus on the UK while others specialise in emerging markets.

Advisers have also been less than impressed with the performance of Absolute Return funds, which returned 4.5 per cent in the year to the end of June. “They’re certainly achieving the low volatility tag but that’s because they’re going nowhere and that’s not good enough,” said Brian Dennehy of Dennehy Weller & Co.

Advisers also say that some fund sectors are too small. They are urging investors to check how large a fund is and whether it is attracting new money from other investors on a regular basis. Managers of small funds that have few inflows can find it difficult to buy new holdings.

For example, the seven funds in the Japanese Smaller Companies sector are particularly at risk of illiquidity, said Patel. This sector was the least popular among investors in June, with net outflows of over £100m.

However, some advisers say definitions can be restrictive. Hargreaves Lansdown continued to recommend the Invesco Perpetual Income fund, which missed its dividend target in 2008, because it believed that fund manager Neil Woodford would lift the dividend over the longer term.

“Two years ago, Woodford was slated for the yield on the fund as it wasn’t meeting guidelines, but he’s one of the few income managers to subsequently grow the dividend for income investors at a time when most other funds have cut them,” Patel pointed out.

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