What you need to know about absolute return funds
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Fund titles containing terms such as "absolute returns" can be misleading, according to Chris Douglas, director of manager research ratings, Morningstar Australasia.
"I've never heard of a fund manager not wanting to generate an absolute return--you don't hear of a negative return fund. Some others you see are called broad-cap funds, and others alternative strategies. We do think people need to be careful about some of these terms and what they really mean," Douglas says.
Absolute return funds aim to deliver returns in both rising and falling markets. To do this, they invest in a wide range of asset classes and employ various investment strategies.
They typically use more complex investment strategies than fund managers in traditional listed investment companies (LICs) and listed investment trusts (LITs), often using strategies and products such as derivatives, taking short positions, or investing in exotic securities.
Underlying investments in absolute return funds may include bonds, currencies, derivatives, futures, metals, money markets, mortgages, options, real estate securities, swaps, stocks, warrants or other specialised financial instruments.
"In many ways, we believe that putting 'absolute return' in the title is very much a marketing-driven exercise," Douglas says.
"We know that investors are seeking out positive returns, so it's important that fund managers are seeking to generate that for investors, but at the same time, if you're going to be investing in equity markets, you need to be wary that you're still going to have that volatility."
He says that even if you're invested in a fund that holds a high cash weighting and the ability to take short positions, "you're still going to have that directional market exposure".
"We see that all the time with these absolute return funds, where they have that market cyclical activity ... they don't actually generate absolute returns."
Monash Investors is a relatively new player within the Australian funds management space, having formed around four-and-a-half years ago, under its responsible entity, Perpetual.
Principals Simon Shields and Shane Fitzgerald describe their investing approach as one of absolute returns.
The fund invests in assets of various sizes, ranging from small-cap through to large-cap companies, and including those that are listed, unlisted, and some that are in a pre-IPO phase.
Fitzgerald describes the Monash approach as "incredibly active," where they are drawn to companies doing something innovative, such as launching an entirely new product or capitalising on a regulatory shift.
He says they like to get in "and take a bottom-up look at the company ... to try and work out where best to expend our effort".
The types of assets they invest in range from late-stage businesses that require capital for an acquisition, through to newer companies, and across a wide range of sectors. Pre-listed companies account for only around 3 per cent of its total portfolio.
Shields says Monash has delivered returns of 12 per cent per annum, after fees, since inception.
What do they cost?
Monash's fee structure is typical within the active management space, charging a base fee of 1.5 per cent plus a 20 per cent performance fee.
Morningstar's Douglas says these high fees relative to other fund types highlight the need for investors to be cautious.
He also points out that the S&P/ASX 200 Index has returned 11.85 per cent over the last five years.
"The market's done pretty well, so they look like they've kept in touch with that ... and the lack of volatility [investors] would have got by being in this fund [relative to investing in the index] is definitely a positive," Douglas says.
"The fundamental view is that investors, of course, want absolute returns, and they compare their investments to bank deposits and what they can earn from these ... it's a very noble pursuit on the part of fund managers [to target absolute returns].
"But you're definitely paying for the added flexibility in the mandate, and the ability to move it around a lot more. There's other costs too that come into play, such as trading costs."
He says that such products can do well in certain market conditions, "but if you have a prolonged bull market, investors can miss out on returns, and can in some ways be worse off [in an absolute return fund] than if they're following a more traditional equity market approach".
As a research house that rates managed funds and equities according to specific qualitative and quantitative criteria, Douglas says Morningstar assesses these products on a case-by-case basis.
"There's not many products like this around in the Australian market, because they've typically lagged the index over the long-term," he says.
"Some fund managers have brought these products out, and they get a lot of money in after a market sell-off, but they do tend to underperform in a bullish market."
While Monash is not a fund that is covered by Morningstar, he says it typically doesn't rate absolute return funds highly, "and a lot of that is around the costs. They are typically a lot more expensive, and we have found very few can consistently add value after fees over a full market cycle".
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Glenn Freeman is Morningstar's senior editor.
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