Absolute return is back as an investment strategy. Sort of.
But, if you delve a bit deeper, the definition of “absolute” in absolute return got a bit muddied— whether it pertained to the length of time for the return or a comparison to the overall market.
Nadia Papagiannis, Alternative Investments Strategist at research outfit Morningstar Inc. [MORN], says that absolute return technically means that a positive return is attained in any market environment, which is not very realistic. “This is a very lofty goal that I’ve never seen any manager achieve,” she said.
But that hasn’t stopped buyers from seeking this Holy Grail. Robert Stein, managing partner of registered investment advisory firm Astor Financial says that clients pay him to not lose their money. He’s a big believer in using exchange-traded funds to create portfolios, and for some of his funds he takes an absolute return stance. If he’s down 2% in a year, he refuses to take solace in the fact that the market may be down, say 40%. That’s not good enough, he says, even if clients are content with it. Indeed, people have become so conditioned to relative comparison, his message of absolute return can be hard to get across, he says.
No wonder. Just 18 months after the worst downturn in 75 years, we seemed for a short time, at least to have a more measured view of risk—complete with pun-filled headlines. Consider this from The New York Times a year ago: "Little is Absolute About Absolute Return Funds."
So, it all begs the question: Are investors really ready to buy again on the idea that some funds can post in the black no matter what?
In an absolute sense, no. But that’s where the new relative twist rears its head. You essentially have to broaden your time frame to include the up-cycles because sometimes—well—you lose money.
“I contend that if you look at a more meaningful investment cycle, absolute return does work,” says Stein. “[Being] down one year is not a red flag to me, but down three years would be.” And to look at the past three years, he says his funds were up about 8%. During that same time period, the S&P 500 Index was down about 24%.
There is a surge in interest in new absolute return products since the crisis. Two recently created funds—the Harness Absolute Return Fund and the Eaton Vance Global Macro Absolute Return Fund—appear to reflect that growing demand.
But, Greg Dowling, Director of Hedged Strategies at Fund Evaluation Group, says, “Some people were badly burned and won’t be back for sure.” With this renewed interest from other investors, he worries that some poorly constructed absolute return products will spring up alongside legitimate ones.
So, what’s an advisor to do? First, you need to re-set your clients’ expectations on what these products can deliver. In fact, just the moniker absolute return is misguided, so Dowling’s shop instead calls them diversifying strategies. “Does it mean that it has to be positive every month, every day, every minute?” Dowling asks. A more realistic approach is to view performance over a more natural investment cycle, he says. And in addition to educating clients, advisors need to continually monitor the investments’ performance, Dowling adds, to make sure the performance is acceptable.
Certainly, clients’ understanding of these products could largely be improved by a better name, but you still need to really convey to them the importance of diversification and the improbable idea of true absolute return. And it needs to delve deeper than a clever headline that says, “It’s all relative.”
