Money managers under the microscope
Among the side-effects of the financial crisis, the importance for European wealth managers and other intermediaries of both managing investors’ expectations and understanding fully what those expectations are, has been underlined.
This is not entirely new. The rise of absolute return products largely reflects intermediaries’ efforts to deal directly with client expectations that, for many, have taken a severe blow. It is worth looking back at the level of inflows to funds seeking absolute returns before and after 2008 (the nadir for the industry in terms of sales activity) to see how this has evolved.
The data not only show the relative level of in- and out-flows for absolute return funds in Europe since 2005, but serves as a means to illustrate how activity has shifted in Europe.
Up to the middle of 2007, investors in Italy, Switzerland and France were strong supporters of absolute return. However the failure of many of these funds through 2007-2008 sent investors running for the door. The best example of this is enhanced money market funds, primarily bought in France, where 31.6 billion euros of sales in 2005-2006 were followed by redemptions of 39 billion in 2007-2008 and essentially no activity since.
As the fund sales trends suggest, many investors were less than impressed with their funds’ performance as the effects of the credit crisis rippled through the financial markets. By early 2008 the banking ombudsman in Lausanne had already received complaints about absolute return products.
The previous year had seen the arrival of the Eligible Assets Directive (EAD), providing legally-binding guidance on which financial instruments could be included in cross-border Ucits funds, following the expansion of their investment capabilities with the implementation of Ucits III in 2003.
The EAD looks to have served as a boost for absolute return fund sales since 2009 (especially when enhanced money market funds are excluded) closer to levels seen before 2008. But there has also been a shift in where investors are coming from, with the UK now dominating.
And just as many Continental European investors questioned the term “absolute return” previously, now similar questions are being asked in the UK. So it’s worth looking more closely at the numbers to see how these funds have really performed.
To do this, we have looked back over the past five years and taken rolling 12-month returns as a reasonable benchmark against which to assess the absolute return funds universe across Europe.
While there are now over 1,000 such funds that Lipper classifies as seeking absolute returns, this analysis generates 29,382 data points – rolling 12-month periods every month for a growing universe of funds over this five-year period to the end of August.
Of this universe, 65.5 percent of the observations (19,245) saw positive returns generated.
Fund companies and researchers have been looking at how to take this broad universe of absolute return funds and break it down into more comparable groups. BlackRock <BLK.N>, for example, has been prominent in such moves (see the story on Fundweb).
Lipper has adopted an approach along these lines for those absolute return funds that do not follow other hedge fund or alternative strategies. This has been developed in order to compare funds whose objectives are not primarily based on what they invest in (say, European equities), but on the positive returns they are aiming to achieve. What one might refer to as focusing on ‘output’ rather than ‘input’.
This method breaks down absolute return funds by currency – reflecting the returns targeted by each fund — as well as by Value at Risk (VaR) to measure the risk associated with the absolute return strategy employed but without assuming normally distributed returns (as would be the case using standard deviation). Using this additional degree of granularity, we can focus on euro-denominated funds (which account for more than two thirds of the universe) and establish that the proportion of periods where positive returns were generated remains similar, at 64.2 percent.
Segregating this universe further, the VaR quantiles reveal just how many similar funds have delivered widely differing proportions of positive returns.
While the VaR fund groupings are the more robust means to compare these funds, it is useful to explain the data shown in this chart in order to appreciate how successful absolute return funds have been overall.
Nine percent of these funds (61 in all) have achieved a perfect record of delivering positive returns in every rolling 12-month period analysed. A further 28 percent have an impressive record of achieving positive returns at least 75 percent of the time. However, there is a sizeable middle ground of 40 percent of funds delivering positive returns between 50 and 74 percent of the time.
At the other end of the scale, extraordinarily, we found that 4 percent (24 funds) failed to deliver a positive return in any rolling 12-month period. Coupled to this, a further 19 percent of funds delivered losses more often than they delivered gains.
So one can conclude that 37 percent of absolute return funds are doing a good job and delivering positive returns at least three quarters of the time, but 23 percent have been more likely to lose money over the course of a year than generate it.
Using VaR classifications enables us to see that if one just looks at the one third of funds with the lowest risk, an improved picture can be found: 56 percent of this sub-group delivered positive returns at least three quarters of the time, while 15 percent have more often failed to deliver positive returns.
For these products to grow further, the chasm that has opened up between expectations and reality must be narrowed for the rump of under-performing funds.
Ultimately, and despite what the brochure might say, absolute return funds present the same problem that wealth managers, financial advisers and fund selectors face in assessing all actively managed funds — sorting the wheat from the chaff.
Those advising investors obviously play a pivotal role in this ‘threshing’ process, but the industry’s farmers – fund companies themselves – also need to address investors’ concerns.
(The Reuters Global Wealth Management Summit is being held this week in Singapore, Geneva and New York. You can catch up with the latest interviews and analysis online)