Absolute return investors trip up on hurdles

Investors putting money into absolute return funds are being advised to check how and when performance fees are applied. Some of these funds deduct 20 per cent of any performance above a “hurdle” rate set as low as the return on cash.

Absolute return funds – which aim to deliver positive returns in any market conditions by taking both long and short positions – are now the most popular in the UK. Figures released by the Investment Management Association show that that the Absolute Return fund sector was the highest selling sector in September – accounting for £442m of net retail inflows, and overtaking the Sterling Corporate Bond fund sector which had spent 10 consecutive months at the top of the sales chart.

Advisers have continued to recommend the funds in recent months. In October, Hargreaves Lansdown revealed that the Cazenove UK Absolute Dynamic fund had become its third best- seller. The November Adviser Fund Index compiled by Financial Express included the Gartmore UK Absolute Return fund among the top recommendations for the first time.

New funds are now being launched to meet this demand, with Jupiter and SEB Asset Management announcing details of their latest offerings this week.

However, advisers warn that private investors may be unaware that absolute return funds carry similar charges to hedge funds: an annual management charge plus a percentage of any performance over and above a stated hurdle rate. This hurdle rate is often as low as the three-month London interbank offered rate (Libor), currently only 0.61 per cent, and the percentage fee can be as high as 20 per cent of any outperformance. It is automatically deducted if a fund’s net asset value is above its “high water mark” (HWM) – the highest value recorded in the previous performance period.

“The Libor hurdle is pretty easy to come by these days,” says John Davey, research analyst at Bestinvest, the advice company. “Taking a fund with any directionality whatsoever, you smash that target.”

A review of absolute return funds by Chelsea Financial Services has found that Libor, or Libid (the rate bid by banks on eurocurrency deposits), is the most common hurdle rate. It is used by the Absolute Insight, BlackRock, CF Octopus, Gartmore and SVM absolute return funds.

Darius McDermott, managing director of Chelsea Financial Services, says: “We like there to be a decent hurdle – Libor tends to be fairly low, we would like to see it slightly higher. For us, an acceptable fee structure is something that gives you a consistent positive return after the charges. The higher the hurdle, the higher the high water mark, the better.”

Jupiter’s Absolute Return Fund, which will launch on December 14, will be benchmarked against three-month Libor. A 15 per cent performance fee will be taken if returns exceed this hurdle rate and, in the first year, the HWM will be set at the initial creation price of the units. There is also a 1.25 per cent annual charge.

SEB Asset Management is launching three funds for UK investors, targeting absolute returns of 2, 5, or 10 per cent above the “risk-free” hurdle rate, defined as the interest rate on a three-month gilt – currently 0.47 per cent. Performance fees are 20 per cent of any outperformance and annual charges are 1.1-1.5 per cent.

But Barclays Wealth says it can offer absolute return portfolios charging only “70 bips” [0.7 per cent] on the underlying funds, a 1 per cent annual charge, and no performance fee.