Absolute Return - Regulation & Sector Definitions
The introduction of UCITS III and Non-UCITS Retail Scheme (NURS) regulations has enabled absolute return funds to be launched and become an integral part of the UK retail fund industry. It has been necessary since February 2007 for UK fund managers to elect to manage their funds under UCITS III or NURS regulations.
UCITS stands for Undertakings for Collective Investments in Transferable Securities and has been applicable in the UK since 2002. UCITS III is a directive from the European Union which provides the guidelines for standardising and simplifying fund prospectuses. The directive allows funds to be marketed freely throughout the EU subject to it being authorised by one member state.
A major effect of the directive, in addition to where a fund can be marketed, is to allow greater flexibility in the investment powers of the manager. Funds may invest in asset classes in addition to the usual equities and bonds. These other classes may include an unlimited percentage of cash where in traditional funds there is usually a limit on the amount that can be held and even the time that it can be held.
NURS regulation does not allow the fund to be marketed in Europe but, as UCITS III regulation, allows a greater range of investment opportunities including direct investment in property. Many fund of funds have adopted NURS as this allows the use of a much wider range of underlying investments. If the fund of funds adopted UCITS III they would have to ensure that any fund they invested in met their requirements.
Hedge funds are able to borrow money to increase the amount of investment within the fund but funds run under UCITS directives are not allowed to borrow cash so the only way to increase investment is to use a synthetic instrument or derivative to gain greater access to the market.
NURS funds are deemed by the Financial Services Authority to be suitable for retail investors, but do not meet the more prescriptive rules of the European UCITS directive. Both of these offer the manager more flexibility than previous regulations, enabling them to adopt more flexible approaches to risk and asset allocation. The following table shows the distinction between the two sets of rules:
| Investment Powers |
|
Fund Attributes |
UCITS III |
Non-UCITS (NURS) |
|
Assets
|
Transferable Securities
Deposits
Derivatives
Money Market Instruments
Other Collective Investment Scheme (CIS)
|
Transferable Securities
Deposits
Derivatives
Money Market Instruments
Other Collective Investment Scheme
CommoditiesProperty
Non UCITS Collective Schemes
|
|
Spread of Risk
|
Unapproved schemes 10%
Unregulated CIS 0%
Commodities 0%
Any one CIS 20%
Trackers 20-35%
|
Unapproved schemes 20%
Unregulated CIS 20% in aggregate
Commodities 20% in aggregate
Any one CIS 35%
Trackers 20-35%
|
Table 1 - Investment Powers
The Investment Management Association (IMA) Absolute Return sector definition
The IMA recognised the momentum in this area of the mutual funds industry and added a new sector in spring 2008 and have recently carried out a review.
Funds managed with the aim of delivering absolute (i.e. more than zero) returns in any market conditions. Typically funds in this sector would normally expect to deliver absolute (more than zero) returns on a 12 months basis.
1. Funds are classified to and remain in this sector on the basis of self election by firms with qualitative oversight by the Performance Category Review Committee (PCRC).
2. There is no asset based monitoring for this sector. Consideration should be given by those listing in this sector to the obligation for Treating Customers Fairly (TCF).
3. Performance comparisons are inappropriate due to the diverse nature of the objectives of the funds populating this sector, including differing benchmarks, risk characteristics and timeframes for delivering performance.
4. Absolute returns are made in the base currency of the fund. Investors may be subject to currency losses should the base currency be different to their domiciled/invested currency. Currently, only funds that are trying to achieve an absolute return in Sterling are classified to the sector.
5. Funds listed in this sector do not guarantee returns.
Following the review the IMA has introduced a 12 month time frame for the absolute return sector funds. The word 'typically' has been included in the definition which warns that there maybe exceptions. There are managers who look to achieve their returns over three or five years, or more vaguely 'a complete market cycle' It must be remembered that not all managers have elected to have their funds in the sector and so the time restriction may not be of concern to them.
Of the 45 absolute return funds listed on Defaqto's database only 19 of the funds have elected to be shown within the IMA Absolute Return sector. Other sectors preferred are Active Managed (3), Balanced Managed (3), Cautious Managed (8), Global Managed (1) Global Growth (1), Specialist (7), UK All Companies (1), UK Zeros (1) and Unclassified (1).
It should be noted that the IMA warn that funds in the Absolute Returns, Specialist and Unclassified sectors are diverse in terms of objective and should not be compared. It is possible that in some cases the only thing in common between two funds may be the fact that they're trying to achieve a positive return.
For a full summary of the Retail Absolute Return Fund Sector, and Funds in other Sectors that Employ Absolute Return Techniques visit : Defaqto Adviser