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GAM meltdown: unrated bond alarm bells ring

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GAM meltdown: unrated bond alarm bells ring

A Chinese chipmaker’s British Virgin Islands subsidiary, a Turkish bank bond yielding over 14% and junk-rated aircraft lease debt were all investments featured in the GAM Absolute Return Bond fund, highlighting the importance of knowing where you are really putting your money.

The demise of GAM’s absolute return bond fund range has had wide-reaching ramifications for both the firm and the wider absolute return bond sector.

Since it emerged that the Swiss asset manager would liquidate its nine-strong absolute return range following the suspension of star manager Tim Haywood, scrutiny has been placed on what these funds were holding.

Among other things, GAM’s review into Haywood found that he made investments into illiquid bonds and other debt securities without conducting sufficient due diligence.

According to the Financial Times, some of the holdings in GAM’s former flagship Absolute Return Bond fund, such as an esoteric payment-in-kind note at a US real estate company, were what could safely be described as illiquid.

For wealth managers and fund investors, the big question is how to avoid such funds – what are the red flags when it comes to these complex funds?

‘If 40% of the portfolio is in things you can’t classify, that’s a warning sign right there’, says David Pegler, founder of Brighton Capital Management.

‘Find out what percentage of the portfolio is somehow unallocated or undisclosed. I’m not saying they’re not legitimate, liquid investments, but it’s important to do your homework to find out what’s in the pot and how much of it is liquid.’

A number of wealth managers are avoiding allocating to absolute return bond funds at all at the moment, but those who are, or have their own multi-asset range, suggest sticking to investment grade.

Rory Campbell-Lamerton, a fund manager at Church House Investments, sees junk rated debt as a possible red flag, with the volatility of these securities not worth the risk.

He says: ‘We wouldn’t look at any junk rated debt at all. To us, with our volatility profile, we wouldn’t be holding any debt at the bottom of the capital structure, it’s just not worth going there.’

Of course a big issue can be when a fund, like the GAM one, has been consistently performing well and you have known the manager for a while.

But Pegler believes it is important not to let complacency set in.

He says: ‘If you’ve known the manager of one of these funds for a long time and the performance has been consistently good, maybe you get a bit comfortable with that and continue to invest without feeling like you need to do the research.

‘But your clients still expect you to do your due diligence. If you’re holding one of these funds and something goes wrong, they’ll be pointing the finger at you.’

The oft-cited trouble with absolute return funds has been both their complexity and their transparency, the latter of which Campbell-Lamerton highlights as an issue.

While GAM revealed that Haywood was not conducting sufficient due diligence on certain investments, it has never been made public which investments these were.

Referring to GAM’s Absolute Return Bond fund, Campbell-Lamerton says: ‘I had a look at the monthly commentary for the fund from October 2017 and it didn’t mention anything about the debt profile, what holdings are in there or the credit exposure.

‘If you are investors in a fund you should have access to what’s under the bonnet and be able to see every holding.’

And when it comes to the investment process of absolute return funds, one criticism often levied their way is the seemingly unnecessarily complicated approach to achieve what are moderate returns.

For wealth managers like Pegler, it can be hard to find the time to fully understand how these strategies work.

The complexity of such funds has presented an opportunity in the market for firms like Square Mile, a research consultancy set up in 2014 and comprised of fund analysts who joined from across the industry.

And due to the increasingly complex nature of some funds like GAM’s absolute return bond range or Standard Life’s Gars, such consultancies are a big help to people like Pegler.

He says: ‘We are struggling to understand some of these absolute return funds. You don’t want to hold the managers back by making it more simple, you want to give them full flexibility so they can provide the returns that they do, but how they do that and how they go about achieving those returns is a bit complicated and difficult
to understand.

While absolute return funds continue to enjoy increasing popularity among investors, the demise of GAM’s range appears to have provided a cautionary tale – always know exactly what you are buying

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