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Do investors understand absolute return funds?

GAM's abrupt liquidation of its absolute return fund range, three of which are offered in Singapore, raise the question of whether targeted investors fully understand the product complexity.

The surprise suspension of the Gam Absolute Return Bond fund (ARBF), and the subsequent announcement to liquidate the range, has sparked more questions about whether investors truly understand the ins and outs of absolute return style funds, according to a report by FSA‘s sister publication Portfolio Adviser.

The industry was caught off-guard by the suspension of manager Tim Haywood in July. High levels of redemptions prompted Gam to gate the range before the fund board ultimately decided the range must be liquidated. (Three of the strategies set for liquidation are available to Singapore’s accredited investors: the Absolute Return Bond Fund, the Absolute Return Bond Defender and the Absolute Return Bond Plus, according to FE data).

Ryan Hughes, head of active portfolios at AJ Bell Investments, says: “The onus is on the investment firm to make sure they are explaining their product in a clear way, that their target customer can understand,” Hughes says. But he says it is difficult to judge whether the fund was too complex for retail investors without a breakdown of all the types of clients that are buying the fund.

Gam declined to provide a breakdown of institutional versus retail money in the fund range.

Portfolio Adviser understands that despite being marketed primarily at institutional clients, the ARBF range, which was managed by Haywood before his suspension, was available to retail investors.

Morningstar head of UK research Jonathan Miller agrees funds like those in the ARBF range require a heavy level of due diligence because of the complex financial instruments they invest in, especially when there are likely both institutional and retail clients in the funds.

Unconstrained bond liquidity concerns

Miller says the fact Gam claimed its ARBF portfolios were liquid but could not meet redemptions is “far from ideal” for a daily liquidity fund.

He notes that many institutional investors would have been forced to ditch Haywood’s funds because they have policies in place which require them to get out if governance issues arise or, in some cases, if there is a management team shake-up.

“If a manager had left and everyone was redeeming at the same rate they did for the manager suspension, would we be left in the same situation? That would be awful that a manager departure means you can’t redeem.”

Adrian Lowcock head of personal investing at Willis Owen thinks the team would have struggled to offload “naturally illiquid” securities like currency options, which there might not have been a big enough market for.

“Those type of investments take time to sell – that’s a fact. The issue with liquidity is if you’re forced to sell, you’re a price taker, not a price maker.”

Lowcock also thinks performance may have also been a factor in some institutional investors’ decision to exit the ARBF funds.

The Gam Absolute Return Bond fund was down -2.55% and -0.15% in sterling terms over one and three years and -3.55% and -4.14% in Swiss Francs over the same time frame.

“At an institutional level, poor performance will not be tolerated for too long,” says Lowcock. “They are much more proactive at switching.”

Financial crisis canaries

Even before Gam’s announcement that it had decided to liquidate the ARBF range, comparisons were being drawn with other infamous canaries in the coal mine in the build-up to the global financial crisis.

Murray Gunn senior European analyst at Elliott Wave International likened the frozen Gam funds to the pair of Bear Sterns unconstrained bond funds that were liquidated months before the crisis began. “We wonder whether the world will look back on this week as having been a similar warning sign,” he mused.

Former investment manager at 7IM Anthony Peters was reminded of the freezing of BNP’s structured funds almost exactly eleven years ago, which could not meet redemptions because “they were stuffed with crap for which there was no bid”.

“Gam seems to be, in some way, in a not dissimilar position,” said Peters writing for Blockex.

“I probably wouldn’t be quite so damning personally,” says Lowcock reflecting on Peters’ take on the Gam drama. The situation at Gam is not happening in a crisis market, “it’s not driven by fear of being the last person holding the low-quality stuff,” he says.

While he was not surprised to hear the fund boards voted to liquidate the funds he agrees that this will help ensure investors are treated fairly and equally and avoid panic selling.

“I think it is good news that Gam have come to this decision fairly quickly and haven’t lingered on it. This means Gam and their investors can begin to look forward.”

Derivatives in absolute return funds

The holdings of the ARBF funds, which include complex derivatives and currency swaps, are not dissimilar to other absolute return bond funds out in the market, says Hughes.

“Given the nature of what they’re trying to do – delivering a positive return from fixed interest – it is inevitable there will be an element of derivative exposure.”

The Gam Absolute Return Bond fund’s largest positions at the end of June were in US treasury bonds (4.35%) and another fund within the ARBF range, the Gam Star Dynamic Global Bond fund, (3.14%), according to a factsheet on the Swiss asset manager’s website.

An asset allocation breakdown shows the fund had 32% invested in AAA bonds, 18% in AA bonds, 17.5% invested in BBB bonds and around 7% in A, B and unrated credit. A little over 9% of the portfolio was designated liquidity in the breakdown.

The fact sheet highlights the fact the fund invests in derivatives and the associated risks but does not provide a specific breakdown of the percentage of the fund invested in these instruments.

A PwC report from June 2017 provides more clarity on the role derivatives played in the fund. It shows the Gam Absolute Return Bond fund had roughly €306.89m ($349.3m) or 10% of total assets invested in derivatives instruments, spanning futures, forward exchange contracts, options and swaps. The full list of derivatives within the fund spans 40 pages of the report compared with just 10 pages for listed and unlisted fixed income holdings.

The Gam Absolute Return Bond Defender and Absolute Return Bond Plus funds, which also feature in the soon-to-be liquidated range, had €18.87m and €244.37m  invested in derivatives respectively, the same report said.

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