Keiron Root’s monthly review of developments in the investment fund markets

Having reported last month that Gartmore was postponing the launch of its proposed European Absolute Return Fund, it is reassuring to note that some stability seems to be returning to the market as Legal & General is going ahead with a similar offering.

DART is the acronym for the group’s Diversified Absolute Return Trust, to be managed by Legal & General Asset Management’s head of asset allocation, David North. He feels that ‘The turmoil in financial markets is changing investors’ expectations of risk and return. Many investors, while not risk averse, are seeking to protect downside risk while
also seeking capital gains. DART is designed to harness investment opportunities across a broad range of asset classes using derivatives and cash instruments under UCITS III regulations.’

Time to deliver
Indeed, this new offering is one of a growing range of absolute return vehicles that seek to produce positive returns in all market conditions. Most have a relatively short track record, so although a portfolio with an absolute return brief should fare better through the current uncertainties than most traditionally managed ‘long-only’ funds, this will be their first major test and it remains to be seen which of the absolute return brigade will actually deliver what they promise.

Certainly the argument appears persuasive. David North insists that ‘DART provides the retail investor with access to investment techniques that have previously only been accessible to pension funds, institutions and hedge funds. Investors can now benefit from macro fund management techniques that may not have been accessible historically. This approach to asset management offers investors the potential for equity like returns but without the volatility associated with traditional equity investment.’

Multiple managers
The desire amongst investors to both spread their risks and have access to a broader range of fund management approaches has also fuelled a rise in interest in multi-manager funds. Indeed, one of the leading providers of such portfolios, Skandia Investment Group (SIG), revealed that 46 per cent of financial advisers expect to put more of their clients’ money into multi-manager funds this year compared with last year, while four per cent expect their use of such funds to decrease.

Even more significantly, professional advisers acknowledge that private investors are comfortable with the multi-manager approach. Seventy-six per cent of advisers said that their clients were happy for such funds to be recommended, of which 62 per cent indicated that their clients understood how multi-manager funds work.

SIG chief executive Jamie MacLeod observed that ‘This level of consumer awareness of multi-manager funds is extremely encouraging. The fact that such a large percentage of consumers understand the benefits these funds can deliver proves that they have truly been accepted as mainstream investment solutions.’

Skandia has certainly been actively managing its multi-manager portfolios in recent weeks, appointing RCM, part of the Allianz Group, to run European equity mandates for its European Equity Blend, Balanced, Cautious and Aggressive funds, and Polar Capital to run its Japanese equity portfolios.

Shuffling the pack
The multi-manager concept has become increasingly popular with management houses as well, leading to this area of the market becoming fiercely competitive. As a result, there has tended to be quite a lot of movement among the managers of multi-manager funds.

The most recent such move came as something of a surprise. At the end of October, Insight Investment announced that the co-heads of its multi-manager team, Patrick Armstrong and Ana Cukic Munro, were stepping down, to be replaced by Mike Pinggera, following a restructuring of the group’s multi-asset business.

Darius McDermott, managing director of adviser Chelsea Financial Services, commented that ‘These changes have come as somewhat of a shock. These funds have performed admirably in what has been a very turbulent period. Both have outperformed over the past year, and Armstrong and Cukic Munro were highly regarded. Insight might argue that they need the expertise on global asset classes, but the fact remains that the team has a strong following and had taken in a good deal of client money, so for me it can only be viewed as a negative.’

He added that this could be the start of a trend as fund management houses reassess their teams. ‘In the light of such controversial changes one might wonder if asset managers are using the current gloomy climate of incessant negative news flow to shuffle their various cabinets around. I expect a lot more manager changes in the coming weeks and months. We can only hope that this shifting around of personnel will lead to stronger teams emerging once markets have stabilised.’

Seeing through the hedge
One group of investments that has suffered in terms of both reputation and performance during the shakeout has been the hedge funds. So much so that the hedge fund managers’ trade body, the Alternative Investment Management Association (AIMA), recently issued a revised guidance note stressing the importance of funds ensuring their ‘capital adequacy’ – i.e. that they have sufficient capital to meet key risks.

Andrew Baker, AIMA’s deputy chief executive, insisted that ‘The hedge fund industry has embraced the capital adequacy debate proactively. Hedge fund managers employ progressive business management techniques and we are fortunate to be able to draw on the expertise of leading advisers from the industry to guide our membership on how to most effectively implement this process.’

Such a proactive stance hasn’t prevented predictions of a major blood letting within the hedge fund sector. Much of this will not directly affect the average private investor, but there is one group of affected funds that is very much on their radar, namely the closed-ended funds of hedge funds, a grouping that, having expanded dramatically over the past couple of years, is now expected to contract with equal speed.

Pruning time
Simon Elliott, head of research at WINS Investment Trusts, argues that ‘The speed and savagery of the derating of the closed-ended hedge funds has been remarkable. From trading on a premium only a few months ago, we estimate that the sector is now trading on a 23 per cent discount. For those who were attracted to the asset class by the promise of absolute returns, the experience has been a disappointing one. With the average share price performance in the fund of hedge funds sector down 39 per cent so far this year, we believe many investors will reconsider whether they wish to remain exposed to the asset class.

‘The majority of funds have a discount floor mechanism that provides a continuation vote if the average discount is wider than five per cent over a 12-month period, often measured on a rolling basis. As a result of the recent derating, the majority of funds with this provision are likely to break that floor within the next six months. We believe that many funds will pre-empt these votes by offering shareholders exits through tender offers or redemption measures, resulting in a significant contraction of the hedge fund sector over the next six months.’

Positive moves
It is still possible to raise funds in this market, if you have a sufficiently attractive proposition. AIM-listed investment company Ludgate Environmental Fund (LEF), which invests in companies within the environmental and ‘cleantech’ sectors, recently raised £18 million of new capital, taking its total assets to £50 million.

Nick Pople, director of Ludgate Investments, specialist adviser to the fund, comments that ‘This third successful fundraising underlines the confidence LEF’s investors have in the fund’s performance to date, its continuing objectives and the investment team. The companies currently in LEF’s portfolio are all revenue generating, and have continued to grow since LEF’s investment.

‘We have continued to see strong investor interest in the sector through the economic downturn. We are also seeing more attractive company valuations in current markets than earlier this year. We expect this to continue in 2009, and for funds with sufficient liquidity and diversity this offers significant investment potential both in terms of value and growth.’

Value among the VCTs
Another group of closed-ended funds that could be well placed to take advantage of any value now appearing in the market is the venture capital trusts (VCTs). Several VCT managers have recently advanced the case that, with bank borrowing in very limited supply, this creates attractive opportunities for VCTs.

Richard Power, fund manager at Octopus Investments VCTs believes that ‘It has been a perfect storm for smaller companies, in that banks have been pulling back on lines of credit, creating a major impact on funding for small companies. AIM is awash with investment opportunities – small growing companies that are feeling the double squeeze of banks withdrawing funding and the reduction in AIM VCT cash available to invest, due to the changes to the VCT rules.’

Stuart Veale, managing director of Beringea, agrees that ‘Growing companies are finding it more difficult to raise bank finance and are increasingly turning to VCTs to fund their expansion plans. Furthermore, companies raising equity finance now have lower valuation aspirations, allowing VCTs to negotiate more attractive investment terms than have been possible over the past two to three years.’

And Mark Wignall, chief executive of Matrix Private Equity Partners, believes that ‘In 2009, VCTs will become a mainstream source of finance for smaller companies to grow and to finance change of ownership. Set against the high street banks’ traditional commanding market share, this change will create a huge new flow of opportunities for VCTs to consider.’