'Absolute returns' eaten by massive fees

Absolute return funds were the fourth most popular category of investment in June, according to the Investment Management Association. But should they be?

Out of 14 such funds tracked by Trustnet.com, only six have made a positive return over the past 12 months. The performance of those that have been around more than a year is even worse: they're down 0.52%. Sure, that compares well to the 15.72% loss for the FTSE 100 over that period, but not to the positive return you could have achieved from a savings account. And it calls into question the claim made by many to be able to make money in falling, as well as rising, markets.

Unlike more traditional 'long only' funds, absolute return funds are not dependent on rising share prices to make money. They can also short stocks a technique that allows them to bet that prices will fall. Most can also pick from a wide range of asset classes, including equities, bonds and money market instruments. So absolute return funds tend to be less risky than a pure hedge fund, and should offer less volatility than an equity fund. That makes them popular investments when the market is diving. So it's no big surprise that they were the third bestselling type of unit trust in 2008.

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But we're not convinced. If you want to preserve your capital, why not put your money in a savings account? And if you're looking for higher, relatively safe returns, we would go for blue-chip shares. Not only are these cheap having not been swept up in the current rally but buying them means you can avoid the galling fees charged by some absolute return funds.

Take the Blackrock UK Absolute Alpha fund. It is up 3% over one year, making it one of the most successful on the market. But it has a heady total expense ratio of 2.62%, due to charging investors 20% of any returns over Libor (the interest rate banks charge each other for loans). Nick Purves' Schroder Income fund, on the other hand, which looks for shares that are priced cheaply compared to the company's underlying assets, is up 6.1%. Top holdings include oil giants Shell and BP, more traditional pharmaceutical bellwether stocks and South African insurer Old Mutual. It boasts a more modest total expense ratio of 1.65%.

And that matters. If you invest £10,000 and assume a return of 7% a year, after 25 years you would have £35,919 in the Schroders fund, or just over £28,000 in Blackrock. Ouch.