Egos and cheques

In late July came the news that the once mighty GARS fund was to close, and with it another checkered episode in the history of UK fund management.

The fund has seen a lot of attention over the past few weeks, and I’m not going to retread that familiar path, but rather take a broader look at the Investment Association sector—Target Absolute Return (TAR)—of which it was a leading member. In 2015 and 2016, TAR had the highest sector net flows, and between 2013 and 2017 it attracted £56.93bn—coming second only to Strategic Bond over the period.

That was the apex of TAR’s success. Fund flows began to slacken thereafter, with outflows every quarter but one (Q2 2018) since Q3 2017. On an annualised basis, flows have been negative every year since 2018, summing to £55.93bn by the end of 2022.

Nowadays, TAR is a shadow of its former self. Indeed, when I googled ‘GARS to close’, the top hit was the opening times of a Chinese restaurant in Brighton bearing the same name. It looks rather good, and I’ll try and pay it a visit when I’m next down that way.

TAR’s dwindling fortunes are to no small degree down to difference between what was promised and what was delivered—something that widened over time.

The sector aims are rather modest: to deliver “positive returns in any market conditions”, although note that “returns are not guaranteed”. At a time when you can make a decent return on cash, this seems unremarkable. But when real rates on cash were negative and nominal rates next to nothing, for many investors it was attractive, and not just the Mrs Migginses tempted away from their cash ISAs and National Savings, but also for institutions such as pension funds.

Annualised three-, five- and 10-year returns to the end of July were 2.44%, 1.7%, and 2.05%, respectively, so on average the sector has delivered on this modest objective. This, of course, is the average of a broad range: from more than 26% to negative 8.4% on an annualised basis over three years, and 8.6% to negative 4% over 10 years.

On a rolling three-year basis, average annualised returns were never in negative territory (the lowest is an annualised mean return of 0.89% for 2016-18, see chart 1). While some funds don’t commit themselves to more than “delivering absolute … returns on a 12-month basis in any market conditions” (according to one KIID), many funds offered more, which is why the money flowed in

This was particularly the case for those funds aiming for four or five percent above Libor before charges^[1] on a rolling three-year basis, as many frontrunners did. GARS, for example, aimed to “exceed the return of six-month GBP LIBOR plus 5% per annum, evaluated over rolling three-year periods (before charges)”.

Choosing from the objectives from some of the larger funds in the sector, one aims to “achieve a rate of return in sterling terms that is equal to or above a minimum return from cash… +4% per annum over five years before fees”. Another “aims to generate a positive return, on average 5% per annum above the Bank of England Base Rate before the deduction of charges, over rolling three-year periods”, with less than half the volatility of global equities.

Being old enough to remember the Long-Term Capital Management debacle, I’m always a little suspicious of financial engineering that promises that the (albeit moderately) good times will roll on—and on. They seldom do.

I have taken the 10 largest TAR funds with a three-year history and ranked them by annualised return gross of fees over the past three years (see table 1). Within the table I’ve also inserted Sonia + 100 to 500 basis points (bps) as comparators, given that Sonia+ is a common benchmark. Only one beats Sonia +500 and +400 bps and only two better +300 bps. Both are Alternative Equity Market Neutral funds.

Source: LSEG Lipper

There are many strategies to choose from within the sector. We need 20 Lipper classifications to cover the 81 active funds, and including merged and liquidated ones there are 29 classifications. This is reflected in the sector definition, which states that “funds may use different benchmarks, manage to different timeframes and present different risk characteristics. For these reasons, performance comparisons across the whole sector are inappropriate”.

That these paths could be so labyrinthine contributed to TAR’s problems. Product complexity is sometimes used by pundits as a reason not to invest. But complexity isn’t necessarily a bad thing: I don’t understand the physics of the jet engine with any clarity, but I still get on the airplane. That said, asset management companies should have a good idea of how they are going to deliver on a fund’s aims. They at least should understand what all the bells and whistles entail.

The IA sector definition goes further, advising that investors “should satisfy themselves that they understand what any given fund is doing – and take advice if they are not sure”. I’m not convinced this happened. I worked at a competitor firm as GARS was in the ascendancy and remember sitting round a table with people much smarter than me as we tried to puzzle what the fund was doing, so we could pitch for a slice of the action. Our puzzlement endured.

Which brings me to the title of this article.

I have never seen Top Gun. However, the one quote I know from Tom Cruise’s magnum opus is “your ego is writing checks your body can’t cash”. This seems apposite given TAR’s history. The prospect of all those cheques looking for a steady return, whatever the market was doing, was too good to turn down. But could they deliver?

The negative flows of recent years are a sufficient answer. Which begs the questions, were those targets viable, and shouldn’t those setting them have known?

^[1]There is a variety of total expense ratios across the sector, ranging from more than 2% to zero, but the average is 113 bps.