Absolute washout for many absolute return funds

Standard & Poor’s Funds Services, the leading provider of qualitative fund management ratings, has revealed that none of the funds in its current survey of the sector met their own investment objectives.

Absolute return funds set their own targets, typically to return a percentage over cash. They use cash as their benchmark and aim to outperform standard measures such as Libor by at least 100 basis points before fees, whatever the market conditions.

But last year all the funds included in S&P’s sector fell short of their return targets after fees, and most failed to match the performance of cash.

Most of the under-performance was due to a difficult year in fixed-income investment, according to Standard & Poor’s lead analyst Kate Hollis, who explained that many funds had incorrect duration positioning at some point, whether from quantitatively-driven models as at Robeco Flex-O-Rente, or from fundamental decisions as at JP Morgan RV4. “A number of funds also had reasonably high exposures to emerging market debt and these were caught by the emerging debt wobble in Q2 of 06.” Hollis noted that risk management processes had prevented several managers from responding effectively to this market wobble.

In asset classes other than fixed income, there were difficulties for fundamentals-driven multi-asset funds from the wide increase in risk aversion affecting emerging debt, emerging equities and commodities among others. The Pioneer Investments Total Return and Fortis Absolute Return ranges were both badly hit and had their first disappointing years.

The impact of poor performance is evident from S&P’s assignment of ratings following its review of 21 absolute return funds over the 12 months to 1 March 2007. There were no AAA ratings and only one AA rating, which went to Mellon Evolution Global Alpha fund. S&P noted that this fund was very different from the other absolute return funds it rates. It uses a quantitatively driven, tactical asset allocation process that invests only in highly liquid bond futures, equity indices and currencies. S&P assigned 15 A ratings to absolute return funds, one fund has been downgraded to Not Rated and four funds are currently Under Review following recent changes in their management teams.

Looking ahead, S&P’s Kate Hollis said a few absolute return funds were on course to achieve their targets by year-end and most were now outperforming cash. A couple were showing losses after fees and a couple were flat by the end of March. “Standard & Poor’s absolute return process compares funds to their own objectives, “ she cautioned, “By definition, we only rate funds that we believe have the potential to achieve their return and risk targets consistently.”