Not so ‘absolute’
BOSTON – When does “absolute” imply something that in reality is far less than certain?
When it comes to absolute return funds. That’s the label mutual fund companies have put on hedge fund-style products that they’ve been rolling out with increasing frequency the past three years. The funds seek to smooth out the bumpy, downward ride the markets have taken lately.
The problem is, the market’s slide has exposed absolute return funds’ big weakness: You can still lose money, even if you manage to fare better than most investors in a downturn. Absolute return funds lost an average 11.7 percent over the 12-month period ended Wednesday, according to Morningstar Inc.
Their three-year record isn’t much better: an average loss of nearly 5 percent per year. The funds are so new that there’s no five-year data.
“All these funds have clauses in the prospectus that say something like, ‘We’ll use our best efforts to achieve this absolute return,’ ” said Adam Bold, founder of The Mutual Fund Store, an investment management company based in Overland Park, Kan. “But I think very few retail investors ever read a prospectus. Instead, what they see are the glossy marketing materials.”
Absolute return strategies vary from fund to fund, but they typically employ methods hedge fund managers and institutional investors have long used to smooth returns, such as short-selling and investing in bonds, futures, options, derivatives, arbitrage and leverage.
The “absolute” label differentiates the funds from far more common “relative return” funds that seek to outperform benchmarks like the Standard & Poor’s 500 index. Absolute return funds seek modest gains regardless of how broader markets perform.
Despite their recent losses, the funds’ performance still looks decent compared with funds investing mainly in stocks. After all, the Standard & Poor’s 500 index lost nearly 39 percent last year.
Avi Nachmany, research director of fund industry consultant Strategic Insight, expects absolute return funds to continue drawing investors nervous about volatility. And although the funds didn’t perform well during last year’s sharp market decline, he says the products still show promise to even out returns over the long haul.
“I think it would be a mistake to project from an event that happens once every 50 years or so, and use that as a rule to base expectations going forward,” Nachmany said.
Critics like Bold argue the funds need to establish a long-term track record before investors should consider them. And with investors so nervous these days, Bold says companies rolling out absolute return funds now are grasping at a strategy to capitalize on fear.
“These funds are being created not by the investment strategy departments of these fund companies, but by the marketing departments,” Bold said. “I think it’s a gimmick. Over time, I don’t know how they can possibly deliver on what people think they’re being promised.”