Absolute return funds dont perform to the name

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Absolute return funds dont perform to the name

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When does absolute imply something that in reality is far less than certain?

When it comes to absolute return funds. Thats the label mutual fund companies have put on hedge fund-style products that theyve been rolling out with increasing frequency the past three years. The funds seek to smooth out the bumpy, downward ride the markets have taken lately.

The problem is the markets slide has exposed absolute return funds big weakness: You can still lose money, even if you manage to fare better than most investors in a downturn. Absolute return funds lost an average 11.7 percent over the 12-month period ended Wednesday, according to Morningstar Inc.

Their three-year record isnt much better: an average loss of nearly 5 percent per year. The funds are so new that there is no five-year data.

The losses may be a shock if you think the funds all but guarantee a positive return.

All these funds have clauses in the prospectus that say something like, Well use our best efforts to achieve this absolute return, said Adam Bold, founder of the Mutual Fund Store, an investment management company based in Overland Park, Kan. But, I think very few retail investors ever read a prospectus. Instead, what they see are the glossy marketing materials.

Absolute return strategies include short-selling and investing in bonds, futures, options, derivatives, arbitrage and leverage.

Despite their losses, the funds performance still looks decent compared with funds investing mainly in stocks. The Standard & Poors 500 index lost nearly 39 percent last year.

The absolute return funds are part of a broader category of market neutral funds that give average investors access to hedge fund strategies.

Putnam Investments has long used absolute return strategies on behalf of institutional clients, and last month launched four absolute return funds for individual investors. The funds seek annualized returns from 1 percent to 7 percent greater than those of Treasury bills.

Investor fees fall and fund managers receive less if a fund fails to hit its target; the opposite is true if the fund exceeds the target.

It puts us on the same side of the table as the client, said Bob Reynolds, Putnams chief executive and president.

Avi Nachmany, research director of fund industry consultant Strategic Insight, expects absolute return funds to continue drawing investors nervous about volatility. And although the funds didnt perform well during last years market decline, he says the products promise to even out returns over the long haul.

I think it would be a mistake to project from an event that happens once every 50 years or so, and use that as a rule to base expectations going forward, Nachmany said.

Bold, of the Mutual Fund Store, argue the funds need to establish a long-term track record before investors should consider them. And with investors so nervous these days, Bold says companies rolling out absolute return funds now are grasping at a strategy to capitalize on fear.

These funds are being created not by the investment strategy departments of these fund companies but by the marketing departments, Bold said. I think its a gimmick. Over time, I dont know how they can possibly deliver on what people think theyre being promised.

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