Absolute-return trend inspires both optimism and caution

Some concerned that a flood of products could hurt investors

Investment News

By Jeff Benjamin May 24, 2009, 6:01 AM EST

A growing emphasis on absolute-return strategies is leaving some analysts advising caution, even though the returns often look good on paper. …

“Right now, there are a lot of red flags to consider, but if they can be overcome, absolute-return strategies could redefine the fund industry,” said Don Phillips, managing director with Morningstar Inc. in Chicago.

Although he likes the idea of an increased emphasis on more predictable returns, he is concerned that some strategies might not live up to expectations and that investors will pour in at the wrong time. …

Don Phillips (photo by Vincent Ricardel)

“This is a strategy that amounts to putting all of the allocation decisions in the hands of a manager,” said Jeff Tjornehoj, senior research analyst at Lipper.

“Ideally, you want a manager who would have moved all the money into Treasuries in October 2007 when the market peaked, but you don't always get that.” …

“Absolute return is going to be huge for all the obvious reasons, including that it allows advisers to dial in the type of returns they want for their clients,” said Robert Reynolds, Putnam's president and chief executive. …

Independence from the direction of the overall market is among the strongest selling points of absolute return. …

LEARNING CURVE

That learning curve will be crucial to managing expectations among both advisers and investors, according to Lee Schultheis, founder and chief investment officer of Alternative Investment Partners LLC, a West Harrison, N.Y.-based firm with $285 million under management.

“People will have to understand absolute return doesn't mean it will always go up, because other than T-bills, nothing will always go up,” he said. …

The inability to manage expectations nearly wiped out absolute-return funds in Europe, where more than 1,000 funds attracted $130 billion in 2005 and 2006.

However, according to Strategic Insight Mutual Fund Research and Consulting Group LLC in New York, misleading promises, poor expectation management and disappointing performance resulted in nearly $100 billion in net redemptions and several liquidations in 2007 and 2008.

“Absolute-return notions of reducing volatility and limiting negative-return periods are enormously and universally appealing yet extraordinarily difficult to construct and deliver,” said Loren Fox, Strategic Insight senior research analyst. …

“Our goal is to hit a targeted return, not to chase an index,” Mr. Reynolds said. …

This gets back to the delicate balance of expectations, according to Mr. Phillips, who underscores the fact that a rising market generally favors relative return strategies that track a market index. …

However, Mr. Phillips added, in this economy, there is something to be said for a smoother and more predictable investment strategy.

“The mutual fund industry has always focused on relative returns in a world where investors are facing real-world challenges,” he said. “Spending needs are more predictable than the market's flow of returns, and these funds focus more on that outcome.”

E-mail Jeff Benjamin at jbenjamin@investmentnews.com.