An advertisement in which the Fundsmith Equity fund compares itself with the absolute return sector under the banner ‘An alternative to alternatives’ has drawn criticism that it could be misleading to investors “plain and simple”.
In its defence, Fundsmith argues that its advert is intended to highlight the potential for mis-selling absolute return funds and the weak outcome that the sector has delivered investors.
Text in the advert – which was run in a number of retail investor-facing publications – pointed out that absolute return funds make use of hedging and derivatives, arguing they are “hard to understand” and do not guarantee a positive return even though they include the word ‘return’ in their name.
It contrasts this with the approach taken by Fundsmith, which has built a strong track record in the IA Global sector on the back of manager Terry Smith’s clear process that focuses on quality businesses.
The advert also includes a graph showing the total return of Fundsmith Equity and the much lower gain made by the average member of the IA Targeted Absolute Return sector.
Source: Fundsmith
When FE Trustnet approached members of the asset management and financial advice sector for their views on the advert, many were highly critical and concerned by it although few were willing to have their comments published on record.
A spokesperson from a multi-manager firm said: “This advert could mislead investors plain and simple. The comparison between the fund and the sector is not appropriate. Absolute return funds are used to reduce risk and volatility in a portfolio and help protect capital and in doing so they have an important role to play in investors’ portfolios. Fundsmith funds look to provide growth and are going to be more volatile.”
“The sad truth is that the industry does little to bring these issues to the attention of the regulator and tend to just let them slide as most fund groups are just as concerned they might be next in line. But clients could make an inappropriate investment decisions based on this advert and that is not acceptable.”
Adrian Lowcock, investment director at Architas, said: “It is important to ensure that when comparing performance of funds you are making a fair and appropriate comparison – it is essential that as an industry we go that extra mile to ensure we are helping investors.”
“In this instance putting a global equity fund against the targeted absolute return sector does not help investors. A global equity fund and an absolute return fund serve different functions in a portfolio and should be complementary, not competitors. The IA Targeted Absolute Return sector is also a broad church of funds with different strategies and objectives so the average is not a particularly useful comparison even for other funds in that sector.”
A senior fund researcher, who also asked not to be named, said: “I think it's totally inappropriate to make that comparison. I can't believe they think comparing the fund to the absolute return sector is appropriate. Terry Smith is a great investor and his fund has made some of the global sector's best returns but it's not an absolute return fund, it doesn't have the aim of making absolute returns and shouldn't be describing itself as an alternative to those funds.”
Performance of funds vs sector and index since launch
Source:
Martin Bamford, chartered financial planner and managing director at Informed Choice, said: “Fund providers need to ensure a comparison with a benchmark is meaningful and presented in a fair and balanced way.”
“Comparing the performance of a global equity fund with the performance of the Targeted Absolute Return sector sounds like an error and I’m sure is something Fundsmith will want to rectify as quickly as possible, so that a meaningful and fair comparison with a relevant benchmark is made. In the absence of a prominent explanation for the reasons why this benchmark was selected for comparison, it strikes me as a very strange marketing decision to take.”
“Using the IA Targeted Absolute Return sector as a benchmark was unnecessary in light of the relative performance of this fund versus the IA Global sector.”
As the chart on this page shows, the fund has performed very strongly relative to its average IA Global peer and MSCI World benchmark since launch in November 2010 with a 183.50 per cent total return – making it the sector’s best performer. It also the best performer over three years and the second best over five years.
That Fundsmith Equity has enjoyed a strong run (its approach focuses it towards quality-growth stocks, which have outperformed by a significant margin in recent years) is not in question but the manner in which has marketed itself is worrying – at least to this journalist and those I’ve spoken with.
There is some merit in Smith’s argument that the returns of some absolute return funds have been so low as to ask whether it was worth owning them, while some in the sector have made heavy losses this year. But the fact that there is an argument for improvements among absolute funds does not mean that a full-on global equity fund would be an appropriate replacement.
As pointed out, a global equity fund and an absolute return fund are often held for very different reasons and most professional investors would be wary of considering the two interchangeable.
As Fundsmith has invited the comparison between the fund and the sector, we looked at some metrics that an investor buying an absolute return fund because they wanted capital preservation might look at: annualised volatility and maximum drawdown.
12-month volatility of Fundsmith Equity and IA Targeted Absolute Return sector
Source: FE Analytics
As the above chart shows, Fundsmith Equity’s annualised volatility has consistently been far higher than the average absolute return fund as would be expected. Since launch, its annualised volatility has averaged 10.48 per cent – five times higher than the absolute return funds.
Meanwhile, Fundsmith Equity’s maximum drawdown of 6.35 per cent has been the lowest in the sector but that’s still more than double the 2.51 per cent posted by the average absolute return fund.
Fundsmith, however, maintains that the advert is appropriate and that the comparison between its global equity and absolute return funds is a meaningful one to make.
A spokesperson for Fundsmith said: “We have chosen to draw a comparison between the performance of the Fundsmith Equity fund and absolute return funds because we became concerned that investors were being mis-sold, which is something the FCA picked up on in their recent Asset Management Market Study, published in November.”
The FCA study highlighted two concerns that the regulator has with absolute return fund: firstly, that many do not report their performance against the relevant returns target but against cash; and secondly that some charge a performance fee when returns are lower than the performance objective the fund is aiming to achieve.
When asked if it was appropriate to compare the performance of full-on equity fund with a sector that aims to minimise losses and make a positive, even if small, return in all market conditions, Fundsmith said: “Yes - page 2 of the October 2016 Standard Life Global Absolute Return Strategies brochure (the behemoth of the Absolute Return sector) states that they intend to ‘deliver consistent, positive returns across all market conditions and that it is an appropriate fund for investors that seek returns that have historically been achieved from conventional long-term equity investment but with considerably less volatility.”
“The Fundsmith Equity fund invests in conventional long-term equity with low volatility so we felt it appropriate to highlight the disparity in performance in our advert and highlight how absolute return funds are not what they purport to be: they have failed to deliver consistent positive performance per our performance table used in the ads.”
FE Trustnet also asked Fundsmith if it feels there is a danger that investors holding absolute return funds then switch into a quality-growth equity fund that might not meet their needs on the back of the advert.
“There would be a danger of them actually making some money as opposed to the poor returns from so-called absolute return funds,” the firm said.
“We would like to point out that two absolute return funds have delivered significant negative returns in the last year to September [these are FP Argonaut Absolute Return, down 21.43 per cent, and City Financial Absolute Equity, down 19.30 per cent].
“We have had no complaints from the FCA or investors about the ads. We have only seen them from advisers who sell absolute return funds to their clients.”