26 January 2011

Absolute Return = No Return?

More and more investors are following the siren songs of the asset management industry and put their faith in the rapidly growing offerings of 'absolute return' funds and investment products. Apart from the fact that providers usually charge higher fees for these vehicles investors should also be aware that the word absolute may have a meaning in other connections but when it is used to describe an investment product's properties it can at best be called nebulous. A quick look at the definition of the word demonstrates that the following meanings can be associated with the term: supreme, total, unadulterated etc. All these connotations have a positive tone and as such one can see that the use of the term absolute is nothing but a clever trick devised by marketing departments in order to lull investors into a false sense of security. Absolute return funds are supposed to stand in contrast to relative return funds. The latter are dominating the institutional fund management space where portfolio managers strive simply to outperform their chosen indices on a relative basis. This can lead to the (absurd) situation that managers that simply lose less than their benchmark index are seen as successful and rewarded accordingly. Absolute return funds are supposed to prevent this from happening by aiming to make a positive return in all market situations. But investors should be aware that the emphasis is on the word 'aim'. There is no guarantee that that there will be any positive return at all. Even worse, given the lack of clear index benchmark it is well possible - maybe even likely - that absolute return funds will under perform compared to the main equity and bond indices when market conditions are favorable.