Absolute return fees soar

25 March 2010

As the absolute return sector swells in size, concern is growing over the high fees levied by the funds.

In the past few months, Legal & General, Gartmore and AEGON have unveiled funds in this space, and a long list of fund management groups, including Aviva Investors, Old Mutual Asset Managers and Deutsche Bank, are planning to launch absolute return products later this year.

There has been explosive growth in the number of absolute return funds available to private investors: three years ago there were just six, now there are 27.

The concept seems attractive: to always deliver a positive return, so that even when markets look volatile, your investments won't take a tumble. This is often achieved by shorting stocks. The catch is that in a bull market a fund will likely underperform the relevant index.

However, some funds are failing to consistently deliver a positive return and many charge hefty performance fees. In February, the average return for an absolute return fund was 0.1%, while the top fund delivered 2.8%. This means some posted negative returns.

The biggest irritation for many IFAs though is the performance fee. Legal & General's two new funds and AEGON's UK Equity Absolute Return fund have a 20% performance fee on top of initial and annual charges.

Jupiter's popular Absolute Return fund, which launched in December, has a 15% performance fee. The hurdle for these fees is typically the Bank of England base rate or LIBOR.

"The performance fee is a nice income generator for fund management firms," says Patrick Connolly, head of communications at AWD Group.

He adds: "Investors will ask why they are paying the high price if the market shoots up and the fund lags the market. There should be a fee reduction for underperformance."

Martin Bamford, managing director of IFA firm Informed Choice, agrees. "With interest rates so low, this is not a particularly high hurdle for fund managers to cross before they get paid even more of the returns from the fund.

"As with all performance fees, there is no return of fees to the client when the fund performs badly," he says.

It's not just advisers who find the fees hard to stomach. Schroders, which does not run any absolute return funds, agrees that some of its competitors charge "extortionate fees".

Robin Stoakley, head of UK retail, says: "If a fund has a target of 6 to 12% return a year, and it delivers 12%, the total expense ratio could hit 3%. This means a quarter of the return is taken up by fees."

He says part of the reason fees are high is because managers are used to running hedge funds "with very fat fees". Stoakley hopes fees will come down.

Richard Pursglove, head of UK retail at Gartmore, admits that fees are higher than long-only equity funds, but says one of the reasons is because only a few mangers can run such mandates.

According to Pursglove, absolute return funds are "on the same journey that corporate bond funds have been on over the past 10 years". He believes the absolute return space will expand just as the corporate bond fund sector has.

Time will tell how the sector evolves. Research by AXA shows that more than 50% of IFAs expect their clients to invest in absolute return funds this year. However, Bamford has seen little interest from investors and says last year only one client asked about absolute return.

This article was originally published in Money Observer - Moneywise's sister publication - in April 2010

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