Worried about Wording: Do “Absolute Return” Funds Suggest Guaranteed Performance?

With a number of mutual funds adopting the term “absolute return” in their names, both retail clients and seasoned investors alike are questioning if the industry really trusts that any fund could persistently generate positive returns – regardless of market conditions.

By definition, absolute return funds strive to produce positive returns in all market environments and are marketed to investors as lower- risk (in comparison to traditional benchmark mutual funds) investments. Promoters of the funds stress the capability of earning positive returns regardless of deep market dips.

In the last few years, alternative strategies have gained appeal given the huge declines seen in the global stock markets. So, given how hard it has been to make money in stocks since 2000, can you really blame the bandwagon- jumping brigade when absolute funds promise they’re designed to generate positive returns on a continual basis?

The funds have come under fire for having misleading titles- potentially causing investors to put blind faith in the strategies.

Yet, advisers warn investors may not find the protection they desire in absolute return funds.

“The name ‘absolute return’ implies positive returns in any market environment regardless of strategy. That mandate is very difficult. We haven’t seen anybody do it,” alternative investment strategist Nadia Papagiannis said.

According to data collected from hedgefundresearch.com, the average absolute return funds lost -13.1% in 2008, -2.6% in 2009 and has just barely broke even in 2010.

With the attention focused on “absolutes,” and their failure to produce as advertised, Mathias Kuhlmey, partner and managing director at HighTower Advisors LLC, expressed the problematic nature of the title and description.

Fee-only adviser and president of Cambridge Connection Inc., Bert Whitehead went further, asserting: “I think calling a mutual fund an absolute return borders on a scam. I wouldn’t touch them.”

Some even argue that Wall Street is playing on public weakness following significant losses suffered during the bear markets of 2008 and early 2009.

In response to the outcry, a spokeswoman from the Securities and Exchange Commission forwarded a copy of the naming-convention guidelines derived from the Investment Company Act of 1940. The rulings explicitly forbid the word “Guarantee” in the title or explanation of any formal language.

However, “absolute return,” does not pose a problem. One blogger agreed in response: “Absolute is not synonymous with guarantee.”

Furthermore, the Investment Company Institute also appears to be turning a deaf ear to complaints that using the term may trigger confusion and unreasonable expectations.

“The mutual fund industry offers investors a remarkably wide range of strategies to suit their investment needs,” ICI spokeswoman Rachel McTague said. “The absolute-return strategy is one of many offered for investors to choose from. As with all funds, the strategy’s approach and risks are described in detail in the funds disclosures.”

Ed Moisson of Lipper recommended investors always read through the objectives of funds as well.

Morningstar, who does not have an absolute return category in its array of index benchmarks, has identified close to three-dozen funds: domestic, international, stock, bond and currency strategies that have recently adopted the absolute return moniker.

According to Morningstar, only four of the 24 absolute-return funds in place at the beginning of the year were able to generate positive results through September. Net inflows into the 24 funds totaled $1.7 billion, with only six providing net outflows. This implies that investors are buying into the hype of “absolute” returns, despite contrary evidence and performance.

Notwithstanding the pessimistic press, some absolute return funds have in fact managed to hit their targets; including Jupiter Absolute Return, which is up five percent in the last three months.

A number of advisors argue that while absolute return funds may offer protection on the downside, losses in excess of 10% hint that cash may be the safest bet.

“There’s a big divergence between how the best and worst absolute return funds have performed,” says Patrick Connolly at financial advisers AWD Chase de Vere.

Ultimately, co-founder of Hennessee Group LLC, Charles Gradante’s simple truth is this: “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.”

 

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