By ANNELENA LOBB
‘Absolute return” funds aim to deliver gains whether markets rise or fall, a goal critics say sets up investors for disappointment.
Most mutual funds have “relative” rather than absolute objectives: they aim to beat or track a benchmark, such as the Standard & Poor’s 500-stock index. But after the stock-market rout in 2008 and early 2009, as well as a decade that ended with little progress by major stock indexes, products that sound like surer bets are gaining traction among skittish investors.
There are now 22 funds with “absolute” in their names, up from four in 2005, according to Morningstar inc. Among the newer entrants is Putnam Investments, with more than $1 billion in a series of four absolute-return funds launched in December 2008. other funds with similar goals exist but may not use “absolute” in their names.
Some question whether the funds can deliver consistent gains.
“The name ‘absolute return’ implies positive returns in any market environment, regardless of strategy. That mandate is very difficult,” says Nadia Papagiannis, alternative-investment strategist at Morningstar. “We haven’t seen anybody do it.”
Different Approaches
There are wide variations among the declared absolute-return funds. Some primarily buy stocks, while others mostly hold bonds. many use commodities, derivatives or other alternative investments, as well as traditional stocks and bonds, to pursue their goals.
Some of the declared absolute-return funds are “long-short” funds, meaning that in addition to buying securities they predict will appreciate over time, fund managers also take short positions in, or bet against, securities they anticipate will fall. The approach, borrowed from hedge funds, potentially allows the funds to make money even in a down market. Goldman Sachs Absolute Return Tracker and Nakoma Absolute Return are among the more than 90 funds Morningstar categorizes as long-short funds.
The absolute-return funds state their objectives in various ways. The Eaton Vance Global Macro Absolute Return prospectus, for example, says the fund’s goal is total return, defined as “income plus capital appreciation.” The fund focuses on fixed income and derivatives in various countries and currencies. “We’re looking to deliver positive returns, year in, year out, in all market environments,” says Michael Cirami, vice president and co-manager of the fund.
Harness Absolute Return, meanwhile, gives its objective in its prospectus as “positive absolute returns above inflation, regardless of the performance of traditional markets.” The document later says the fund “seeks to provide returns above inflation of three-to-five percent over rolling three-year periods with moderate levels of volatility.”
The four Putnam funds aim to beat inflation by a set margin—seven, five, three and one percentage points, annualized, respectively—”over a reasonable period of time (generally three years or more).” Putnam Absolute Return 100 and Putnam Absolute Return 300 invest across global fixed-income sectors; the 500 and 700 funds buy a mix of bonds, stocks and alternative assets.
Mixed Returns
Results so far have been mixed, and most funds don’t have long track records. Funds with “absolute” in the name have returned 0.67% so far this year and 11.56% in the past 12 months, on average, through March, according to Morningstar. Those averages lag behind both stock and bond funds in general: Stock funds have returned 5.02% this year, and 56.88% in the past 12 months, on average; bond funds returned an average 2.03% this year and 17.34% in 12 months.
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Some of the absolute-return funds show negative returns. Nakoma Absolute Return is down 2.59% year-to-date and down 10.37% in the 12 months through March, says Morningstar.
“If you look at what happened last year, we were long higher-quality and short lower-quality” companies, says John Mueller, head of marketing and client services. But lower-quality companies led the rally that began last spring, he says.
Others have fared a bit better. Eaton Vance launched its fund in June 2007, though it managed institutional money using the same strategy from 1997 to 2007. The fund, with a recent $1.9 billion in assets, has returned 1.79% in 2010 and 11.47% over the past year, through March, according to Morningstar. The company says the fund and strategy haven’t had a negative 12-month period over the past 10 years.
Putnam Investments says it is optimistic about meeting its goals over three-year periods. Putnam Absolute Return 700, which aims to top inflation by seven percentage points, has returned about 12.22% annualized from inception through March, according to Morningstar. The 500 Fund has returned 8.53%; the 300 Fund, 6.85%; and the 100 Fund, 3.35%. Returns are for Class a shares. Inflation has been about 2.7% from January 2009 through February 2010, according to the most recent data available from Morningstar.
“I don’t think we’ve set our sights too high,” says Jeff Knight, managing director and the head of global asset allocation at Boston-based Putnam Investments. he says absolute return “is the next big category in the mutual-fund business.”
Jeff Dunham, chief executive of Dunham & Associates Investment Counsel inc. in San Diego, also anticipates a major push into the category. Dunham manages approximately $1.1 billion, including the absolute-return-oriented Dunham Monthly Distribution, with a recent $61 million in assets, according to Morningstar. Mr. Dunham says that in a year or so, with interest rates potentially on the rise, there will be enormous demand for more investments that produce a reasonably steady rate of return and aren’t bond funds.
Bond funds took in a lot of new money in 2009. But if interest rates and inflation climb, he says, investors are likely to get hurt. “When people say, ‘Where should I go?,’ we and our other long-short friends will be there,” Mr. Dunham says. his firm plans to launch a second absolute-return fund in coming weeks.
Even Vanguard Group, known for low-cost investing, is considering giving retail investors access to an absolute-return fund. in January, Vanguard filed an exemptive-relief form with the Securities and Exchange Commission. If relief is granted, it would allow the three Vanguard Managed Payout funds to invest up to 20% of assets in Vanguard Alternative Strategies Fund, an Irish-domiciled fund that uses absolute-return strategies but currently has no public shareholders. The Managed Payout funds—which aim to provide steady retirement income while preserving principal—presently invest in funds that hold stocks, bonds, cash, and other assets.
Vanguard hasn’t decided whether to proceed if it gets SEC approval. Still, the firm “may be able to provide some value-added in this space, if we can do it the way Vanguard does things—low cost, and so on,” says John Ameriks, a principal and head of investment counseling and research. Absolute-return investments could diversify a fund or portfolio, he says, but they aren’t “a silver bullet.”
—Ms. Lobb is a writer in new York. she can be reached at reports@wsj.com.
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