Jeff Salway: An absolute scandal in the making

THE history of market investment is littered with lessons from which we have failed to learn.

That failure comes at a price, as investors invariably discover when they fail to heed the warning signs.

A sudden inflow of private cash into certain funds or sectors is one such indication that all may not be what it seems.

A decade ago, millions of private investors were licking their wounds after chasing a dotcom boom that defied common sense. The love affair with commercial property funds in the mid-Noughties also ended in tears for those who piled in late in the day, many of whom were then locked into loss-making funds as providers slammed shut the exit doors.

Now there must be concerns over absolute return funds. When one such vehicle attracts net inflows – money in after redemptions and withdrawals – of more than £670 million in just three months, you have to ask why.

The Standard Life Global Absolute Return Strategies (Gars) fund now has more than £11.3 billion under management. You read that right: £11.3bn. More than £676m of that was invested in the last quarter.

Why is so much money flying into the fund? Nerves, largely. The growing army of fund groups promoting absolute return funds are in the tiny minority feeling grateful that, somehow, George Osborne remains Chancellor. They are benefiting from our woeful economic performance, uncertainty over the Eurozone and a crisis in confidence that has investors scurrying for shelter.

On the face of it, absolute return funds can offer that shelter, hence their popularity. This isn’t about the Gars fund specifically, but about the alarming surge of money into a group of funds that, so far, have flattered to deceive.

Absolute return funds promise the best of both worlds: a combination of growth and insulation from volatility. They claim to achieve that by using tools and strategies that very few financial advisers can truthfully say they understand, let alone the average investor.

Not only are they complex, but many of the funds are failing to live up to their promise. Investors attracted by the prospect of downside protection are now nursing losses. That may change – investing is a long-term game, ideally – but around half the funds with performance records going back three years are in the red.

We potentially have a mis-selling scandal on our hands. The City watchdog warned as much earlier this year. Why are advisers flogging investment funds they don’t understand? Many of the funds rely heavily on derivatives. Those tools might work, they might not, but the point is that their complexity means advisers and investors cannot measure the risk to which they are exposed.

As ever, while the Financial Services Authority casts its eye over absolute return funds, investors are jumping into the sector without looking where they are going.

History lessons are valuable for good reason. In this case, at least two niblets of investment common sense are important to heed: if you don’t understand it, steer clear; and if it sounds too good to be true, it almost certainly is.