FCA delays funds findings as absolute return investigation confirmed

The UK’s Financial Conduct Authority (FCA) has announced a delay to the publication of its interim report on the asset management market study as it admitted that it is investigating absolute return funds.

The UK’s financial watchdog’s market study into asset management was announced when the FCA published the terms of reference of the market study in November 2015. The interim part of the report was expected to be released very soon and set out those areas that the FCA believes raise concerns and those where no or few problems have been found in the industry.

However, the FCA has said that it is now due to be released in Q4 this year with the final report set for early 2017. The delay is understood to be due to the regulator’s investigation into absolute return funds.

Over the past two years absolute return funds, which aim to provide positive investment performance across all market conditions by trying to bypass the volatility of equity markets, have proven popular with investors.

Negative returns

However, despite the popularity, two-thirds of UK-domiciled absolute return funds, which are on course to register a record year of net inflows, have posted negative returns in 2016. This has led to concerns about how the funds are being marketed to investors.

“We are looking at absolute return funds as part of the overall study,” a spokesperson for the regulator confirmed to FTfm earlier today. “Across the market study we are looking to understand how competition works for asset management products and services,” the spokesperson said.

Patrick Connolly, Certified Financial Planner at IFA Chase de Veer (pictured), told International Investment that while he welcomed the investigation he also warned the regulator not to dismiss the asset class completely.

“In an environment where equity markets are likely to be volatile and many parts of fixed interest seem over-priced, there should be an opportunity for absolute return funds to demonstrate they can have an important role to play providing capital protection in investment portfolios,” said Connolly.

‘Nasty surprises’

“However, the vast majority of absolute return funds and the sector as a whole haven’t managed to earn the trust required to step in, even at this time when they could be most needed. Too many of these funds are too highly correlated to stock markets and so when markets struggle a large proportion lose money. This could provide some nasty surprises for investors.”

Connolly points that this doesn’t mean that all absolute return funds are bad and welcomes the future launch of more income generating absolute return funds that, he says, would give further choices for investors.

“Funds that we presently recommend include Newton Real Return and the Aviva Investors Multi Strategy Target Return funds,” he said. “However, we can’t escape the reality that the absolute return sector as a whole is generally charging investors too much and then delivering too little.

“Even when stock markets rise many funds achieve little more than cash-like returns and they do it with much higher charges, sometimes including performance fees which are earned for beating a notional benchmark which is often less than 1% per annum.”

‘Hidden’ fees

Connolly warns that these performance fees, which, he worries, can be ‘hidden’ in the small print of fund manager’s documents, are often charged at “a whopping 20% of outperformance for beating a very low notional benchmark such a LIBOR rates (currently around 0.5% per annum)”.

“If a fund manager is confident in their ability to out-perform and wants to apply performance fees the fairest way is first to reduce their ongoing annual charge and second to introduce a meaningful performance hurdle,” he said. “Funnily enough, managers don’t seem particularly keen to do this.

“The Schroder Absolute UK Dynamic fund, for example, has a 20% performance fee. In their last financial year this meant an extra 1.48% charge to investors on top of the ongoing annual charge of 1.67%. In the past 3 years the total cumulative return to investors has been just 5.1%.

“The FP Argonaut Absolute Return has a 20% performance fee. It returned 40%, 14% and 12% in 2013 to 2015 respectively, no doubt generating some pretty chunky performance fees. Perhaps investors won’t be so keen to see the fund is down by more than 20% in the current year,” said Connolly.

Assets under management in UK-domiciled absolute return funds rose to £59bn last year, an all-time high. The funds have attracted another £5.3bn in the first six months of 2016, putting them on course to match last year’s net inflows of £10.8bn.

Gary Robinson
Head of Video and Ezines at Open Door Media Publishing. Deputy Editor, International Investment. An experienced journalist and filmmaker with more than 20 years' financial services experience, both as journalist and originally as a fully qualified IFA, Gary works across both International Investment and InvestmentEurope titles. Previous video production credits include projects on BBC, C4 and SKY.

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