At times like these, when it seems that every effort is made to protect investors, it boggles the mind that regulators and the financial services industry overall can't see the irony in mutual funds' using the term “absolute return.”
The idea of a fund that strives to achieve a positive return, as opposed to one that aims to beat a benchmark regardless of its performance, is a wonderful idea and something for which all money managers should be striving.
But in adopting the name “absolute return,” as a growing number of mutual funds are doing, it seems that the fund industry is pushing the limits of marketing by implying that a fund will generate positive returns all the time, regardless of market conditions.
“I think calling a mutual fund "absolute return' borders on a scam,” said Bert Whitehead, a fee-only adviser and president of Cambridge Connection Inc.
“I think it's pretty blatant misrepresentation,” he added. “I wouldn't touch them.”
Morningstar Inc. doesn't have an absolute-return category as part of its broader alternative category, but it has identified about three dozen funds that have adopted the term.
Of those funds — which cover the full gamut of domestic, international, stock, bond and currency strategies — a dozen were launched just this year, and only 10 were around three years ago.
In response to a request for comment on the subject, a spokeswoman from the Securities and Exchange Commission forwarded a copy of the naming-convention guidelines from the Investment Company Act of 1940.
The language in the guidelines goes into considerable detail on how the word “guarantee” can't be used.
“Absolute return,” on the other hand, which certainly sounds like a guarantee to me, doesn't appear to trouble the SEC.
NO ISSUE FOR SEC
“The SEC should have an issue with the term "absolute return,' but they don't,” said Geoff Bobroff, a mutual fund industry consultant.
“The SEC is very slow to address these types of issues,” he added.
The Investment Company Institute also appears to be shrugging off the notion that using the term “absolute return” might lead to some investor confusion.
“The mutual fund industry offers investors a remarkably wide range of strategies to suit their investment needs,” said ICI spokeswoman Rachel McTague.
“The absolute-return strategy is one of many offered for investors to choose from,” she added. “As with all funds, the strategy's approach and risks are described in detail in fund disclosures.”
Nobody can fault the fund industry for jumping on the bandwagon of the latest hot dot. Alternative strategies are gaining appeal because the broad markets are volatile and largely negative.
Who wouldn't want to invest in a fund that is designed to produce positive returns all the time?
But in practice, that isn't even close to what investors are getting.
The average return this year through September of the absolute-return funds tracked by Morningstar was a 4.4% decline, a respectable relative return compared with the 10% drop by the S&P 500.
But for most investors, “absolute return” is going to lead to expectations of positive returns.
In fact, just four of the 24 absolute-return funds that were around at the start of the year were able to generate a positive, or absolute, return through September.
Meanwhile, net inflows into those 24 funds this year through September totaled $1.7 billion, with just six of the funds experiencing net outflows.
This clearly shows that investors are buying into the notion of absolute returns, despite the actual performance being generated.
“The impression they are giving is that they will always have a positive year,” said Charles Gradante, co-founder of Hennessee Group LLC, a hedge fund consulting firm.
“Clearly, they are misleading the retail market, and they're also misleading a lot of sophisticated investors,” he added.
The initial push-back from the fund companies representing absolute-return funds is that the strategy is distinct from relative-return strategies that are pegged to benchmarks.
While I can appreciate the idea of identifying a benchmark to beat a relative-return strategy, one would hope that any money manager is first and foremost always shooting for an absolute return.
“It is something the industry has created to make money,” said Matthias Kuhlmey, a partner and managing director at HighTower Advisors LLC, which has $20 billion under management.
“I find the description questionable, and I'm not sure I know what it even means,” he said.
Frustrations over the “absolute-return” moniker have been around for a long time in the hedge fund industry, where the term originated.
“The only absolute guarantee you have as an investor is that the market will go up or down, and you may or may not make money,” said E. Lee Hennessee, co-founder of Hennessee Group.
It is one thing when the “absolute return” term is confined to the hedge fund space, where investors are supposed to be rich and sophisticated, but the use of the term in the retail-mutual-fund space prompts the question of whether the fund industry is overstepping in an effort to promote alternative strategies.
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