Mutual fund companies that are looking to attract investors are betting on the words “absolute return.”
Twelve absolute-return funds have been launched since the start of last year, bringing to 32 the number of funds with “absolute” in their titles, according to research firm Morningstar Inc. The funds have little in common beyond their names, which makes evaluating them difficult except for the most-experienced investors, Bloomberg Businessweek.com reported.
The idea of “absolute return” is primarily a marketing concept that has gained popularity since the
recession and stock market decline, said Nadia Papagiannis, an alternative-investment strategist at Morningstar. Funds labeled “absolute return” follow a number of strategies and imply that investors won't lose money and will always make money, she said.
“It preys upon people's fears that another 2008 is going to happen,” Ms. Papagiannis said.
The funds use bonds, derivatives, commodities, currencies and stocks in strategies designed to produce consistent returns unaffected by broader market moves.
“"Absolute return' describes the goal rather than the investing strategy,” said Joseph Jennings, an investment director for PNC Wealth Management who uses some of the funds for his clients. The aim is to “generate positive returns in any market environment and do so with fairly low volatility,” he said.
Financial advisers such as Keith Amburgey at Rutherford Asset Planning Inc. said that they are investing in the funds amid concerns that interest rates will rise and decrease the value of bonds, which generally have been used to provide consistent, steady returns.
INTEREST RATES
“If you're worried about interest rates, you end up turning to these to fill out your portfolio,” said Mr. Amburgey, the chief investment officer at Rutherford.
Absolute-return funds try to reduce market risks such as interest rate changes or falling stock prices.
The $3.4 billion Absolute Strategies Fund (ASFAX) from Absolute Investment Advisers LLC uses 13 different strategies. The Eaton Vance Global Macro Absolute Return (EAGMX) fund, the largest absolute-return fund with $7.6 billion in assets, invests in global debt, currencies and derivatives.
A similar approach is used by the newest fund, the Legg Mason BW Absolute Return Opportunities Fund (LROIX), which was launched Feb. 28.
It is difficult to compare funds against each other, so investors “need to look under the covers and understand what the fund strategies are,” said Robyn Tice, a spokeswoman for Eaton Vance Corp.
Eaton Vance's absolute-return fund became so popular that the firm closed it to new investors in October, she said.
For most of the funds, “you don't have enough of a track record to make a prudent decision,” said David J. O'Brien, head of O'Brien Financial Planning.
The track record of older funds is mixed.
Of the 10 absolute-return funds that existed in 2008, all but two lost value. For example, the Absolute Strategies fund lost 14% that year while the S&P 500 dropped 38%.
Investors should read descriptions of fund strategies carefully and try to gauge the skill of fund managers.
Absolute-return funds tend to borrow the approaches of hedge funds, according to Ms. Papagiannis.
Because many of the funds hedge market risk with derivatives, much depends on these strategies' details.
Derivatives are contracts whose value is derived from stocks, bonds, loans, currencies and commodities, or linked to specific events such as changes in interest rates.
“There aren't too many managers you want to
trust with that,” Mr. Amburgey said.
Investors need to learn as much as possible about a portfolio manager and make sure that he or she is “smart and knowledgeable,” he said.
Evaluating absolute-return funds isn't something that can be done by the vast majority of investors or even their advisers, Mr. O'Brien said.
Although absolute-return funds are designed to be less volatile than the markets, “they're still risky,” said Robert Dowling, a financial adviser at Modera Wealth Management.
Because their performance can be unpredictable, it is best not to bet on just one alternative approach, he and other advisers said. Mr. Dowling recommends that clients buy several funds or make sure a fund includes several different strategies, as the Absolute Strategies Fund does.
Absolute-return funds have other disadvantages.
Because most trade often, any gains may trigger higher short-term capital gains rates.
Fees may also be higher. Expense ratios for absolute-return funds may vary from less than 1% to almost 3%, according to Bloomberg data. Expense ratios will decline with time, Ms. Papagiannis said.
LABOR-INTENSIVE
Absolute-return funds may not be worth the effort that it takes to evaluate them and fit into a portfolio.
If an investor's goal is to reduce volatility, he or she should stick with investments such as bonds, said Robert Schmansky, founder of Clear Financial Advisors.
For example, Treasuries can be bought and structured in a way that they provide a guaranteed income stream much like an annuity, he said. Called “laddering,” the technique involves the purchase of bonds with varying maturities that correspond to when the investor needs cash flow.
“After the fees and costs of these funds, there are better options out there that have more of a track record,” Mr. Schmansky said.
