INsider: Absolute return absolute nonsense

The idea of an absolute return, as opposed to a relative return that strives to beat a benchmark, is a wonderful idea and something that all money managers should be striving for. But in adopting the name “absolute return,” as a growing number of mutual funds are doing, it seems the fund industry is pushing the limits of marketing by implying that a fund will generate positive returns all the time. Morningstar Inc. doesn't have an absolute-return category as part of its broader alternative category, but it has identified about three dozen funds that have adopted the term. Of those funds — which cover the gamut of domestic, international, stocks, bonds and currency strategies — a dozen were launched just this year, and only 10 were around three years ago. Nobody can fault the fund industry for jumping on the bandwagon of the latest hot product. Alternative strategies are gaining appeal because the broad markets are volatile and largely negative. The latest performance data from the hedge fund industry stands out as more proof that alternative strategies have the potential to add real diversity and help dampen portfolio volatility. The short biased subcategory of the Hennessee Hedge Fund Index, for example, gained 9.7% through September of this year. That compares with a 10% drop over the same period for the S&P 500. But it's worth noting that of the 23 hedge fund index subcategories, only four generated positive returns through the first nine months of the year, proving that not all alternatives are created equal, nor should they be. That brings us back to absolute-return mutual funds, an idea that sounds absolutely peachy on paper. A fund that produces positive returns all the time? Where do I sign up? But in practice, that's not even close to what investors in absolute-return funds are getting. The average return this year through September, as tracked by Morningstar, was a 4.4% decline. Granted, that's certainly better than the 10% drop by the S&P 500. But from where I'm sitting, it's not an absolute return. In fact, only four of the 24 absolute-return funds that were around at the start of the year were able to generate a positive, or absolute, return through September. Meanwhile, net inflows into those 24 funds this year through September totaled $1.7 billion, with only six of the funds experiencing net outflows over the period. This clearly shows that investors are buying into the notion of absolute returns — despite the actual performance being generated. “The impression they are giving is that they will always have a positive year,” said Charles Gradante, co-founder of Hennessee Group LLC, a hedge fund consulting firm. “Clearly, they are misleading the retail market, and they're also misleading a lot of sophisticated investors,” he added. The initial resistance from the fund companies representing absolute-return funds is that the strategy is distinct from relative-return strategies that are pegged to benchmarks. That differentiation is likely lost on most investors. And while we can appreciate the idea of identifying a benchmark to beat a relative-return strategy, one would hope that any money manager is first and foremost always shooting for an absolute return. Frustrations over the absolute-return moniker have been around for a long time in the hedge fund space, where the term originated. “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,” said Lee Hennessee, co-founder of Hennessee Group. Phil DeMuth, managing director at Conservative Wealth Management LLC, describes the term “absolute return” as a “marketing gimmick.” It is one thing when the term is confined to the hedge fund space, where investors are supposed to be rich and sophisticated, but the use of the term in the retail-mutual-fund space just prompts the question of whether the fund industry is overstepping in an effort to promote alternative strategies.