European absolute return (AR) and multi-asset flexible funds have not performed well in the first three weeks of August and did not always sufficiently protect investors during the market volatility this month, Fitch Ratings said.

Aggregate data from Lipper showed that European AR funds lost 2.5% and flexible funds lost 7.6% in the first three weeks of August, resulting in year-to-date negative performance of -3.5% and -8.9%, respectively.

Despite aiming for positive returns in all market environments, not all funds in the top quartile of European AR funds have managed to preserve capital so far this year.

Flexible funds avoided 70% of the August market decline, but only half of them outperformed a balanced bond and equity allocation. Therefore they have also not reached their aim to provide asymmetric returns relative to a balanced bond and equity allocation by dynamically changing market risk exposures.

"Making up for the 2011 losses has become a major challenge for many absolute return and flexible funds," Manuel Arrive, senior director in Fitch's Fund and Asset Manager rating team, said. "As a result, the worst performers are likely to be driven out of the market, as investors discriminate based on performance."

The magnitude of the general market sell-off in August caught investors by surprise, according to Fitch. Many asset managers were too slow to lower their portfolios' overall risk budget or move into cash. In addition, Fitch's analysis indicates that downside protection mechanisms such as hedging strategies at times proved ineffective.

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