Emerging markets may yet pay dearly for the sins of their richer cousins. While recent financial crises have been rooted in the United States and euro zone, analysts at Credit Agricole are questioning whether a full-fledged emerging markets crisis could be on the horizon, the first since the series of crashes from Argentina to Turkey over a decade ago. The concern stems from the worsening balance of payments picture across the developing world and the need to plug big  funding shortfalls.

The above chart from Credit Agricole shows that as recently as 2006, the 34 big emerging economies ran a cumulative current account surplus of 5.2 percent of GDP. By end-2011 that had dwindled to 1.7 percent of GDP. More worrying yet is the position of "deficit" economies. The current account gap here has widened to 4 percent of GDP, more than double 2006 levels and the biggest since the 1980s. The difficulties are unlikely to disappear this year, Credit Agricole says,  predicting India, Turkey, Morocco, Tunisia, Vietnam, Poland and Romania to run current account deficits of over 4 percent this year.

Some fiscally profligate countries such as India may have mainly themselves to blame for their plight. But in general, emerging nations after the Lehman crisis were forced to embark on massive spending to buck up domestic consumption and offset the collapse of Western export markets. For this reason, many were unable to raise interest rates or did so too late. As the woes of the Turkish lira and Indian rupee showed last year, the yawning funding gap leaves many countries horribly exposed to the vagaries of global risk appetite.

There are some supportive factors however. The Fed's signal this week that  U.S. interest rates are unlikely to rise before 2014 shows  that central banks in Europe and the United States will continue to gush money for now. So there should be enough cash available to plug the gaps in emerging nations' balance sheets. Second, as growth eases, so will the deficits.  For these reasons, Credit Agricole says the market will be forgiving of large current account deficits this year. But it warned:

What will happen once (developed market) rates are raised is another story, and emerging markets would better have fixed their main imbalances when the global monetary normalisation begins.

"How Italy plays out will be important but people should not exaggerate its global importance.  In the next 12 months the four BRICs will create the equivalent of another Italy."

Emerging economies are cooling now after years of turbo-charged growth. But according to O'Neill, even then they are growing enough to allow the global economy to expand at 4-4.5 percent,  a faster clip than much of the past 30 years. Trade data for last year will soon show that Germany for the first time exported more goods to the four BRICs than to neighbouring France, he said.

"Post-crisis, these countries will be our passport out of this mess."

But there has to be a payoff for this kind of increased financial clout, he warns. Developing countries are increasingly disgruntled about the the richer world's strangehold on global policies via the International Monetary Fund and the World Bank and most have responded coolly to the call for additional funds for the IMF which is fighting to stem the euro zone malaise. An attempt last year to install a representative of the developing world at the helm of the IMF for the first time ever fell apart, with Europe retaining the position. But emerging countries could make a bid for the World Bank chief's position this year, a position traditionally held by a U.S. citizen. O'Neill said the West had to bow to the new reality:

"You can't have it both ways...This game of 'You have the IMF and I have the World Bank' has to stop or these institutions are going to lose their relevance."

He is also dismissive of fears China is headed for a so-called hard landing, a sharp slowdown of growth, potentially leading to unemployment, a property crash and social unrest in the world's No. 2 economy.  "A lot of people (in the West) want China to have a hard landing, " he said. "And that's because it isnt us."

In searching for answers to these questions, I spoke to Paul Moulton, a professional gambler who originally worked in the fund management industry. He then set up a fund research company (Fitzrovia International, which he eventually sold to Reuters), although his working life began with an attempt to become a professional chess player.

Most of the fraternity of professional gamblers who make a living from horse racing are what Moulton describes as ‘traders’ or ‘chisellers’.

This group do not really look at horses at all, but look at market movements, hedging back their bets, and aiming to make tiny but regular profits with much less risk. They remain tucked away in their homes in front of an array of computer screens.

Moulton sees himself as part of a second, smaller group of professional punters, those he refers to as ‘judges’, some of whom look at horses in the paddock to assess their physical condition and thus their chances, while others are more reliant on assessing form based on previous races.

Some of them may even be conscious of the FSA’s warnings on funds’ past performance, which is deemed to be no guide to future returns. Although past performance does tend to shorten a horse’s starting price.

As part of this approach, Moulton has gathered vast amounts of data on all aspects of racing (jockeys, trainers, pedigrees, speed figures and so on) in a database that covers all horses in all races in the UK and Ireland since January 2005.

Although his background in fund research lends itself to such an approach, Moulton admits that, while his original idea was to “out-stat” everyone else, this approach has turned out to be much more limited for determining which outsiders to back.

He did try to do all of this from home, but in the end he was better able to deal with losses when trackside. The journey home enables Moulton to carry out a post-mortem of his performance, win or lose, and to clear his mind before returning to the family.

So he now spends more time looking at the horses in the paddock too, even though being at a course means that it is a little more “archaic” when trying to work out “what the market is doing”. But even this has a beneficial side-effect: it is far easier to bet on too many horses in too many races when sitting at home and betting over the internet, he says, while, for practical reasons, this is far less the case when at a course.

TOO MUCH INFORMATION

Moulton acknowledges the above findings from Russo and Shoemaker. From his own experience of building a horse racing database, he is all too aware of the desire to add in a new piece of information after virtually every race.

In the early days this process of amassing more and more data on which to base decisions was “comforting” he says, but he has found that “it doesn’t help results.” The more detailed any extra analysis that he runs, the smaller the sample size becomes (for more recent races) and the less meaningful the findings are.

“Once filtered to that degree, apparent patterns are really just statistical tricks.”

At its heart, Moulton’s approach to placing bets is to look for value in the market. He creates a ’tissue’ for each race, assessing the price at which he would be prepared to back a horse and then compares this to the odds offered by a bookmaker.

Moulton tries to divorce himself from picking winners.  ”Anybody can pick winners,” he says. “There’s no point in picking winners if you’re backing them at the wrong prices, because sooner or later you’ll come a cropper.”

It’s for this reason that he’s always reluctant to answer the question from the occasional punter “who is going to win the 2.30 at Haydock?”

“In all likelihood I’ll back several horses in the race if I think they’re good value and still expect to lose, which most [amateur] punters can’t quite get their heads around.”

Yet after all this work over the past five years of professional gambling, it might come as a surprise that 93 percent of the time Moulton’s chosen horses lose.

Luca Cumani, one of British racing’s leading trainers (and who trains some horses that Moulton owns), on hearing this said, “if I got 93 percent of my decisions wrong, I would not be able to call myself a professional anything.”   Moulton’s response to this is that it doesn’t matter as long as the average odds of his selections are greater than a 7 percent chance (or 13-1) because, in the end, “it’s all about profit”.

In the same way, if typically one backed horses at 33-1 (i.e. a 3 percent chance of winning), then one could get away with losing 96 percent of the time and still make a profit. This contrasts with picking 2-1 shots (a 33 percent chance), where one has to be right more than 35 percent of the time.

In Moulton’s view, each gambler has to decide where on this ‘risk spectrum’ he believes he can succeed, much of which comes down to temperament. Most professional gamblers are focused on those horses with shorter odds, while Moulton chooses horses with longer odds but has to deal with losing more frequently.

He admits that there are very few punters at his end of the spectrum. But this does not come as a surprise, indeed he seems to relish the apparent loneliness. As he says, “it does do funny things to your brain when you lose 93 percent of your bets!”

Whatever happens, he can draw more than a little comfort from the fact that all his work is tax free (since the 9 percent betting commission was abolished a decade ago) and has gone to great lengths to check that HMRC will not come knocking at his door . It is as though all of his investments are held in a huge ISA wrapper.

To hit the golden 7 percent, he spends over 80 hours a week at work. His unwavering logic is that to spend that amount of time he needs a decent return, and to do this he needs to place a decent stake.  So Moulton fairly routinely turns over £100,000 a day at the big festivals and consequently turns over several million pounds a year.

“I don’t think there’s a serious professional gambler who has made 10 percent of turnover” he says, so his daily stakes of a few hundred pounds back in 2006 were simply not high enough to earn the sort of living he wants to sustain.

Even to make £25,000 a year, on 5 percent of turnover one would need to turn over £500,000 a year or £2,000 a day.  As a result, Moulton concludes that “betting on horses is only 50 percent of a professional gambler’s skill, the rest is in temperament and stake management, both if betting too much and too little.”

DEALING WITH LOSING

The biggest challenge for Moulton remains how to deal with losing runs when a 7 percent success rate looks further and further away.

For Moulton it is in the nature of things that he will hit bad spells as winners don’t come neatly spaced between losses. His approach requires consistency but a run of losers has often tempted him to start tinkering with that approach in order to try and end the losing streak – a fatal error.

This has clear echoes of the pressure on fund managers to deliver short-term returns despite managing money for the long-term. Perhaps Professor John Kay, who is leading an independent review into long-term investing in UK equity markets, has considered talking to professional gamblers.

Moulton has learned this the hard way. Each year he has gone through a “horrible, horrible losing run” and each year he has tried to train himself to deal with it better.  Indeed early on he admits to losing all confidence in his abilities.  He puts such losing runs down to being in his chosen end of the risk spectrum and he admits it would be “far better for my mental health” if he could find a proven method of making money from backing 4-1 shots.

Despite this, after five full years of betting, with 7,000 to 9,000 bets each year, Moulton has experienced two years that were essentially flat (before expenses) and three “pretty spectacular” years.

The occasional anonymous mention in the pages of the ‘Racing Post’ stands as testament to some huge wins. In July 2008 one columnist wrote in disbelief at meeting Moulton and finding that he had won £200,000 and £250,000 within a few weeks of each other. And in September this year he made nearly £600,000 over two pool bets.

INSIDER?

More generally, when considering the similarities with investing in the stock market, Moulton points out that the vast majority of the time, the competitive environment in which companies operate changes relatively slowly, enabling analysis to be carried out over a reasonable length of time and in depth.

He contrasts this with the competitive environment for a horse race that can change in moments – and often does, such as the previous race highlighting a bias relating to positions in the draw. And of course a horse race is over within a matter of minutes. Moulton has not had to develop the equivalent of a ‘buy and hold’ investment strategy.

While he may have found an asset class uncorrelated to stocks, bonds or even gold, indeed even the euro zone crisis does not figure very prominently in the minds of punters, if oil rich Middle Eastern owners such as Godolphin (the Maktoum family’s private horseracing stable) decided to leave British racing, this would surely send an earthquake through the sport.

Meanwhile, Moulton’s own moderate success as an owner — despite friendships across a range of trainers and jockeys — gives the lie to the idea that apparent ‘inside information’ is the key to success.     Indeed much trackside information is available to all, with those in the paddock able to tweet their views to punters within moments. Moulton himself is an avid tweeter  – @moulton66. So “market chatter” is increasingly open – and you don’t get much more transparent than when a horse is sweating!

As for dealing with bookmakers, his response makes clear the implicit trust in those relationships: “If I had to choose one group of people with whom to do business the rest of my life, it would be bookies.”

THE BITTER END

Moulton would not be drawn on whether his family was the equivalent of dealing with investors in a mutual fund, although he has avoided running a syndicate because this would end up with him being answerable to shareholders. Instead he asserts that he is better at being a professional gambler than anything else he could turn into a career and so it offers the best chance for him to support his family comfortably.

What might be seen as a risky career is bolstered by steadfast confidence. “Even if I lost 50 percent of my capital, I would – I would, I would, I would – turn it around.”

So in 2010 when he sold his beloved E-Type Jaguar to raise some cash, he did not adopt a more cautious approach and proceeded to lose the money made from the sale in 45 minutes on the racecourse.

So how far would he really go? “I would go all the way.”

Conviction, dedication, self-awareness and a consistent investment process. Surely attributes all investors long for in a fund manager; although you would allow them some nerves if the trackside approach to capital preservation turned up in their fund factsheet.

(Editing by Joel Dimmock)  ((joel.dimmock@thomsonreuters.com; Twitter: @reutersJoelD; +44 20 7542 3505;))

Exchange traded funds (ETFs) have found themselves under ever more scrutiny from regulators and market participants this year and expectations are that new rules for the sector are just a matter of time.

It’s tempting to think of ETFs as unwilling victims of new regulation, but to my mind, ETFs have much to gain.

The point is that it isn’t just regulators who are seeking improved transparency on fund holdings and on the use of derivatives by mutual funds, crucially it is end-investors too. And once the fog has cleared, they might come to see ETFs — with daily published portfolios and clearer statements on the use of derivatives in general — as a role model for all kinds of mutual funds.

The discussion surrounding ETFs could leave you with the feeling that they are unregulated products; that fund promoters can go wild when creating new products and with the use of derivatives in the portfolios. In reality though, ETFs follow the same local and/or international legislation of any other mutual fund; the EU UCITS regime for example.

So, why all the fuss around ETFs? In my opinion, there is nothing uniquely wrong with these products as they are using the same tools and techniques used by other funds under the UCITS regime. Some authorities, however, have raised questions as ETFs grow in popularity among professional investors. A deeper look into the questions posed shows that the points made by the critics are not only applicable to ETFs, but to any mutual fund.

CONCERN

I wonder if the popularity of ETFs, which have sold well in tough market conditions, has made them a useful conduit to raise more general concerns about the mutual fund industry as a whole.

Of course, some of the concerns mentioned by market authorities are reasonable points to make, but they apply far more broadly; derivatives in general and swaps in particular are nothing new, and alongside stock lending, are widely used within the asset management industry.

Yes, ETFs have been a sales success, but for all the fanfare, they still account for less than 10 percent of assets under management in the global fund industry. In what is a well diversified range of products, to my mind this does not constitute a structural risk.

So perhaps ETFs have become a victim of their own success, as regulators jump on the most popular fund products in recent times to highlight concerns about the complexity of some fund types and about the use of derivatives and stock lending in the investment industry more widely.

I think there can be no doubt all this attention will lead to new regulations for the all mutual funds. But contrary to the expectations of most market observers, I think this new regulation will change the landscape for “regular” mutual funds much more than the environment for ETFs. After all, relatively speaking, ETFs have a useful head-start on transparency.

The sector won’t escape unscathed. Some asset classes like commodities are only investable via the use of swaps under the UCITS directive and investment here is likely to face a shake-up. The ETF sector is also likely to find itself subject to a redefinition of funds into complex and non-complex products as regulators seek to better safeguard retail investors; the performance dynamics of products like short or leveraged long ETFs, after all, are beyond the understanding of the average private investor.

A closely-watched survey from Bank of America Merrill Lynch out on Tuesday showed a near 50-50 split among fund managers expecting a country possibly leaving the 17-member currency bloc.

And some of our participants at the Reuters Investment Summit last week put a high 70-75 percent chance of some countries leaving the euro zone next year.

Swiss wealth manager Sarasin reckons the impact will be a meteor striking the earth and offers following scenarios:

• A run on the banks by savers keen to put their money into a core euro country would bring down the banking system of the departing country overnight.
• Companies and private households would not have access to loans, nor would they be able access any more cash.
• The state, which in this situation should support the banks, would be bankrupt as well. Financial markets would deny it access to funding.
• The new currency, once it is introduced, would depreciate by between 30% and 50%, which would multiply the government’s debts.
• The depreciation would lead to imported inflation and trigger trade union demand for compensation, setting off a hyperinflationary spiral.
• The bankruptcies of banks in Southern Europe would bring about the downfall of their northern counterparts because the latter have lent them large sums of money in the belief that monetary union would last forever.
• Anticipating an appreciation, huge capital flows would drive up the new Deutschemark. Many medium-size companies would become uncompetitive overnight.

"There are thousands of venues for how a meteor could approach earth and there are thousands of conceivable but unlikely scenarios how the euro could collapse which would substantially alter investors’ optimum positioning... Investors should know that there is no refuge from a euro collapse," Sarasin's chief economist Jan Poser says.

History is written by the victors. That is what emerging markets discovered after their currency crises of the 1990s, and it is what will happen when the annals of the euro crisis are compiled. Treatment of this crisis has varied, but in all its forms the basic premise is already set: Germany and the world are the undeserving victims of Peripheral European excess.  The Periphery spent and borrowed too much causing the current crisis.  Add to this the cultural imagery of Greek pensioners retiring at the tender age of 55 on exotic Aegean islands at German savers’ expense and the colourful chapter on this historical saga is written.

If Emerging Markets is any guide, the problem with this narrative is not just that it is wrong, but downright dangerous in its policy implications.  The tyrannical hold of this perspective on European policy making is pushing the continent down the path of a historic pro-cyclical fiscal contraction almost as the be all and end all of crisis response.  There is already a mountain of evidence that this has not worked, whatever the merits of debt reduction and ideological divisions on its pace and timing.  The missing ingredient has always been and remains today, quite different.  Italy and Greece lack a central bank.  More importantly, they deserve one, desperately.

For an economy where paper money is the medium of exchange and fractional reserve banking exists where a bank transforms a unit of deposits into a multiple of that in loans, a central bank is essential.  This is as true of Switzerland as it is of Greece.  It performs a function of lender of last resort to prevent a rapid run on an otherwise solvent bank (a liquidity crisis) from turning into a solvency one for that bank or for the entire banking system.  When Italy and Greece signed onto the Euro, they had a legitimate right to expect that the Central Banks they were giving up would be replaced by a common Eurozone one, which would in effect perform the same function for their economies.  What they got instead was a Central Bank which is constrained by mandate, and German objection to its modification, from performing that function for anyone but Germany.

In the Eurozone, not only are the ECB’s clients the member state banks, but also the sovereigns.  We are in the advanced stages of a full blown and contagious run on both, with the ECB for all intents and purposes on the sidelines.  Whatever support it has provided so far in the guise of purchases of distressed member state debt and bank liquidity provision has been trivial in relation to the size of the run, and communicated in such a tentative way as to aggravate it, by signalling impotence.  The ECB’s absence, whatever its legal justifications, has effectively reduced Italy and Greece, not to mention the Eurozone, to the status of a barter economy.

Italians and Greeks can and should justifiably ask for redress.  They did not give up their Liras and Drachmas to be put through a fiscal vice as the cost of the most basic central banking services being provided them, any more than U.S. states did for the same service from the Federal Reserve.  The lender of last resort function is a relatively uncontroversial one, which has little to do with ideological debates about the desirability or effectiveness of active monetary policy or with Weimer Republic-induced phobias of hyperinflation and money printing.  The idea, that in the middle of a full-blown bank/sovereign run, a central bank’s intervention would be made conditional on preceding actions, fiscal or otherwise, that are subject to political vagaries, is extraordinary and dangerous.

A confidence crisis is precisely that; it cannot wait and must be dealt with decisively and conclusively if the vicious cycle is to be arrested.  This is not to say that the fiscal and debt problems which challenged confidence to begin with should not be addressed; they should.  However, in this European version of the Emerging Markets archetype, we are in now well beyond the phase where a medium term fiscal adjustment announced by technocratic governments in Greece or Italy will have any effect.  It maybe part of the solution, but it is certainly not sufficient, or the most urgent issue.  The ECB needs to act and act big.

Periphery Eurozone states have a legitimate existential grievance that has gone essentially unnoticed in the current crisis narrative.  They were not admitted into the Eurozone merely out of German altruism.  Germany may pretend otherwise but it derives a clear benefit from not having Italy and Spain devalue at its expense, as they used to with regularity in the past.  For these countries to be condemned to a decade-long common monetary policy, where rates were set to suit larger economies like Germany, and subsequently a global financial crisis, where their right to a lender of last resort function is denied, is laughable.  In fact, the fiscal union altar on which the ECB and bailout is conditional is itself a canard.  Both Germany and France were in violation of the Stability Pact 3 percent budget deficit rule and conveniently gave themselves exemptions.  Spain today has a public debt to GDP ratio some 20 percentage points below Germany’s.

This is not a story of German benevolence and peripheral European excess.  It is a story of extraordinarily poor institutional design, for which a read of Emerging Markets history might be instructive.  Italians and Greeks should demand that the ECB start acting like their central bank, and have its legal framework modified if need be to do so.  Their argument should be simple, if it does not, it will become nobody’s central bank, because there will no longer be a Eurozone.

Spare a thought for the fund managers trying to make their business work in the Middle East and north Africa (MENA) this year.

Those investing in home markets have faced the uncertainty and drama of the Arab Spring and the wear and tear on affected markets. The Egyptian Stock Exchange was closed for several months while in the Gulf Cooperation Council (GCC) countries, all markets ended the first half in the red (even if the Abu Dhabi index and the Saudi Tadawul All Shares resisted well, down 0.57 percent and 0.67 percent respectively.)

Moreover, the fund industry in the region faces some deep structural flaws.

Taking the GCC alone, there are 101 fund management companies in the region managing $28.5 billion of assets between them, according to Lipper data. Those firms run a total of 337 funds with average assets under management at $84 million; taking a median figure to iron out the inflating effect of a few bigger funds that figure is just short of $20 million. To see a graphic showing AuM by asset class in the GCC, click here.

The six biggest funds in the region had cumulated assets of $10 billion and represented over a third of the market at the end of September. To see a graphic of the top funds, click here.

The upshot of this is that, at the other end of the spectrum, a quarter of the market is comprised of funds with less than $6.6 million under management.

This is not a healthy place to be. Small funds are not profitable for a fund company. In Europe, it is agreed that the threshold for profitability is around 10 million euros ($13.8 million).

In the GCC, funds should breakeven at a lower AuM level than that because of lower fiscal and regulatory pressures. But even if we take $6.6 million as the threshold it means that at least a quarter of the funds domiciled in the GCC are losing money.

Of course, funds have been deeply impacted by the sustained nature of the financial crisis; this year alone redemptions hit $1.8 billion between January and August, while there has been an inevitable depreciation of assets due to market declines. Mutual funds in the GCC have on average lost 9.67 percent since the beginning of the year, Lipper data show. To see a table of GCC fund flows over the last 5 years, click here.

SHALLOW POOL

There’s a more fundamental problem too. Fund managers in the GCC have the advantage of a deep understanding of their local markets but they’re running out of people to sell to. The market for retail investors is simply not big enough to absorb that many funds. Indeed, even though we talk about the GCC market as a region, it is worth noting that there is no facility for cross-border sales, a clear obstacle to the growth of funds. The obvious comparison is with Europe, where cross-border sales have allowed funds to expand through multiple markets, while we have six countries in the GCC and six distinct retail markets.

And when they do sell, it’s into a shallow pool. Even though the main distribution channel is through retail banks the culture of fund investing is not yet rooted in people’s behaviour. And that’s assuming they had the cash in the first place; revenue distribution in the region is skewed, leaving the vast majority of the population with few investable assets.

It is true that in some GCC countries, the fund market is enlivened by western expats and middle-class local populations. But these investors favor offshore funds which are usually distributed through segregated accounts or through fund platforms. Many investors will prefer to trust offshore funds — particularly if they want to invest outside the region or in niche markets — because of the fund companies’ market experience and brand recognition.

There are some steps the parent companies can take in the face of these pressures.

As the GCC local markets are relatively small, funds which are losing assets and/or posting poor performance cannot be easily merged or absorbed by other funds to benefit from the advantage of economies of scale, not least because most fund companies have only a single fund per strategy. That said, fund firms can take certain steps to strategically review their fund families and aggregate assets into bigger funds over time. And on a higher level, mergers between companies should be able to improve average assets under management which should in turn lead to lower fees for investors.

As the region is one of the least impacted in the current debt crisis there is also room for local fund managers to capitalize on one of the key trends in the asset management industry to find specialized managers with an in-depth knowledge of smaller markets. Stock picking and a full understanding of local markets have become fundamental in generating alpha and combined with a more robust AuM and the credibility and reassurance that can provide, there are the beginnings of a route through our present stormy waters.

($1 = 0.727 Euros)   (Editing by Joel Dimmock)  ((joel.dimmock@thomsonreuters.com)(Twitter: @reutersJoelD) (+44 20 7542 3505))

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.

To view the chart, click here.

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.

BENCHMARK

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.

To view the performance chart click here.

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)

For a populace fearful of seemingly inextricable connections to a wider world they can't control, it's not difficult to see the lure of petty nationalism, protectionism and isolationism. Just witness national debates on the crisis in Britain, Germany, Greece or Ireland and they are all starting to tilt toward some idea that everyone may be better off on their own -- outside a flawed single currency in the case of Germany, Greece and Ireland and even outside the European Union in the case of some lobby groups in Britain. But it's not just a debate about a European future, the U.S.  Senate next week plans to vote on legisation to crack down on Chinese trade due to currency pegging despite the interdependency of the two economies.  And there's no shortage of voices saying China should somehow stand aloof from the Western financial crisis, even though its spectacular economic ascent over the past decade was gained largely on the back of U.S. and European demand.

Despite all the nationalist rumbling, the crisis illustrates one thing pretty clearly - the world is massively integrated and interdependent in a way never seen before in history. And globalised trade and finance drove much of that over the past 20 years. However desireable you may think it is in the long run, unwinding that now could well be catastrophic. A financial crisis in one small part of the globe will now quickly affect another through a blizzard of systematic banking and cross-border trade links systemic links.

Just take the euro zone for a start. HSBC economists on Friday said the costs of a euro zone breakup would be "a disaster, threatening another Great Depression" and far outweighed the costs of repairing the flawed fiscal backstops to the monetary union -- especially given the wealthier creditor countries within the union tend to ignore the benefits they've reaped from the euro over the past 12 years. Aided by the "entangling effects" of the euro, it showing that cross-border holdings of capital have exploded from about 20% of world GDP in 1980 to stand at more than 100% now (global GDP was estimated by the IMF to be about $62 trillion last year). By contrast, the first wave of globalisation in the late 19th and early 20th century saw cross-border holdings peak at 20% of world GDP before WW1 reversed everything.

"A euro break-up would be a disaster, threatening another Great Depression," wrote HSBC chief economist Stephen King and economist Janet Henry. " Cross-border holdings of assets and liabilities within the eurozone have risen dramatically, leading to a tangled web of mutual financial dependency. With the re-introduction of national currencies, disentanglement would proceed at a rate of knots, undermining financial systems, generating massive currency moves, threatening hyper-inflation in the periphery and triggering economic collapse in the core."

That tangled web of trade and finance, however, goes well beyond the euro zone. One of the reasons the fast-growing emerging markets look, for the second time in four years, set to succumb to the western financial crisis is that western banks -- European banks in particular -- provide them with so much finance. RBC economists, citing data from the Bank for International Settlements, shows outstanding European bank lending to emerging markets at some $3.4 trillion -- almost 10 times that of the U.S. banks and more than three times Japanese bank lending.

JP Morgan, meantime,  reckons a one percentage point decline in western real domestic spending growth (GDP less net exports) leads to a 2.7 percentage point drop in exports from emerging economies as a whole. If their forecast for a recession in the euro zone and US slowdown to 1 percent annualised growth by the middle of 2012 proves correct, then that should slow EM export growth to 6% annualized in 4Q11 and just 4% annualized in 1H12 from double digit growth rates earlier this year. While that would still be far better than 2008/2009 emerging export collapse of about 20%, the projected pace of export growth would still be weaker than at any point in the expansion of the 2000's save during the SARS scare.

It's not hard to prove these linkages everywhere and the scale is now astronomical. What's harder to make sense of is how world leaders cannot seem to grasp that they and we are truly all in this together and going it alone is no longer a truly viable option without major unquantifiable upheavals.