The Lonsec Australian Equity Sector Review, released today, said disappointment with the performance of more traditional benchmark tracking Australian equity product designs had led to the development of more absolute return and index unaware investment products.

“One of the areas of innovation on the Lonsec Australian equity landscape to develop critical mass in recent times comes as little surprise,” said Duncan Knight, Senior Investment Analyst.

“Industry innovation now sees quality offerings coming to market that offer exposure to the Australian equity market without the limitations of being restricted to benchmark relative active positions.

“While absolute return funds are not formally a sector in-and-of-itself, these products bring an important perspective to the traditional benchmark aware investment designs. However, this space is quickly evolving into heterogeneous compote of designs, philosophies and opportunity sets.”

While innovation in product design is a welcome development, constructing a portfolio using these products can be a problematic. The Lonsec review found that complexity considerations are paramount when considering using products in this space, as some funds have very simple pragmatic designs and some are necessarily labeled hedge funds.

“The lack of homogeneity within the space, with product designs spanning from fully invested benchmark unaware funds, through to funds that are able to vary their exposure to the equity market, makes apples to apples comparisons difficult,” Mr Knight said.

“Based on their differentiation, one could reasonably apply a ‘handle with care’ sticker to these funds. However there are many positive features worth considering,” said Mr Knight.

Absolute return products are not just seeing growth in the Australian equity sector. “You could argue that the Australian equity manufacturers as a whole are laggards in this area,” Mr Knight said.

“The income and multi-asset sectors have long had absolute return style products and have evolved the product offerings significantly in recent times.”

As Lonsec noted in its 2012 Multi-Asset Sector Review: “Investors at or nearing retirement are beginning to look for outcomes based, or real return solutions, rather than peer relative performance.”

In the Australian equity space, until recently, established managers haven’t been as willing to ignore ‘peer risk’. However Lonsec said the product development trend will continue, “particularly if the equity market returns remain volatile and as the concept of ‘not being able to eat relative returns’ gains more traction and resonates not only with manufacturers, but more importantly, investors,” Mr Knight concluded.

Lonsec conducts its Australian Equity Sector Review across all Australian equity sub asset classes during the same review cycle. By aggregating the sub asset class reviews into one broad program of assessment Lonsec can enhance the guidance and insight it provides.

The post Absolute return funds show innovation and growth appeared first on AdviserVoice.

“Beta 1 style funds will typically maintain a net equity exposure of close to 100%, with the proceeds from short selling reinvested in their long positions. Short selling is primarily used to enhance overall fund returns and comes with increased market risk.”

“Variable beta style funds may utilise a broad range of strategies including short selling, gearing, derivatives and cash in order to adjust their net equity position in line with the investment manager’s market outlook.”

Of the 12 funds reviewed, none attained Lonsec’s top rating, Highly Recommended.

Sector themes and observations

High quality PMs entering the sector

While the universe has not increased all that dramatically, Lonsec is of the opinion that it has evolved with the introduction of a number of competing teams with strong skill sets and experience. “Historically the retail long short sector has been dominated by successful long only managers launching active extension or long short strategies,” commented Ngin.

“Lonsec believes that the shorting element is a specialist skill set and has tried to differentiate between solid long only investors versus investors with extensive track records in shorting.”

Post the GFC, the quality of personnel within the long short space has increased, especially at the portfolio manager level.

“We have seen a number of hedge fund investment professionals gravitate to the retail space, leading to greater sophistication and greater dispersion in portfolio manager skill sets and short selling experience,” said Ngin.

Key person risk is high

Key person risk for many managers is relatively high, given the additional specialist skill set required for the effective implementation of the shorting component of a portfolio.

“While we see this as a potential risk, at Lonsec we believe that key person risk is often worth taking,” said Ngin. “That said, in the event that a key person ceased to work within an organisation, the rating of the Fund would be reviewed.”

Stop losses – stopped out

While the market only returned 3.8% for the year to May 2011, it should be noted that this was a relatively volatile period. As a result, it wasn’t unusual to see managers being ‘stopped out’ of their short positions. Managers that employed less rigid approaches to their stop losses were more likely to benefit from this volatility as they were less likely to be stopped out of positions that would later turn profitable.

“While this strategy may have worked in the favour of managers with the less rigid approaches to their stop losses over the last 12 months, Lonsec acknowledges that good risk management in long/short investing is important and that improperly managed short positions can result in significant losses,” observed Ngin.

The post Lonsec releases its Australian Equity Long/Short Sector Review appeared first on AdviserVoice.