Study: Funds Lure Wary Investors With ‘Absolute Returns’

Friday, 18 Jun 2010 02:12 PM

 

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With volatility scaring many U.S. investors away from stocks, the mutual fund industry is finding that one of its hottest products is a type of hedge fund for the masses promising steady if unspectacular returns.

Investors looking for safety poured $4.2 billion into "absolute return" mutual funds in first five months of 2010, up sharply from $394 million a year earlier, according to Thomson Reuters' Lipper unit.

The funds invest in more complex instruments than conventional mutual funds, and tend to charge higher fees. Their missions vary, but most aim to deliver a positive return or beat inflation, rather than benchmarking themselves against specific market indexes.

Many of the new types of funds appeared during the financial crisis, built on the lesson that individual investors dislike volatility. U.S. stock market indices have yet to fully recover from 2008 losses and have been fluctuating wildly in recent weeks, making more investors willing to pay for predictability.

"A reason they're so powerful now is that investors have woken up and said, 'There is risk in investing,'" said analyst Scott Burns of Chicago research firm Morningstar Inc. "That's why the marketing message is resonating so well."

Like hedge funds, which are reserved for the very wealthy and often require $1 million or more in minimum investments, most absolute return funds allow managers to buy and sell more complex securities than traditional mutual funds. Their growing popularity suggests a psychological shift among investors, executives say.

"People are more focused on returns and less focused on mirroring the market," said Dan Cataldo, vice president for analysis at Eaton Vance Corp.

One of Eaton Vance's fastest-growing funds is its Global Macro Absolute Return Fund, whose holdings include derivatives and junk bonds. Of $4.5 billion in assets, about $1 billion came in during the three months that ended April 30.

That is also a sign of a lasting change in investor outlook, Cataldo said. In the months to come, "there will be a demand for traditional equity products, but my guess is it's not going to be as great as prior to the downturn," he said.

The new funds carry their own risks, though. Financial planners caution that some may prove so conservative that investors miss out on future stock run-ups.

Also, their short records also make it hard to judge their performance. For instance Morningstar tracks the record of the Eaton Vance fund only since 2008. (It is up 3.05 percent year to date through June 16, well ahead of peer funds that were down 0.08 percent, but trailing a comparable bond index.)

Fund companies could use some winners. Investors pulled $7.3 billion out of U.S. equity mutual funds in May while putting $6.1 billion into U.S. bond funds.

Analysts say the outflows from equity funds — which until last month had just started to catch up with bonds' steady inflows — reflected recent challenges for the stock market, like the debt crises in several European countries and BP's oil spill.

Also tarnishing equities was the still-unexplained "flash crash," when the Dow Jones industrial average fell roughly 700 points in minutes before rebounding sharply.

"If you greet investors with a big bucket of water in the face, they change course very quickly," said Lipper research manager Jeff Tjornehoj.

The flow patterns have soured the mood in the $12 trillion mutual fund industry because companies typically make more money from managing equity funds than on the fixed-income or money market sides.

But absolute return funds may be the great hope for the short-term, as their fees track higher than conventional funds.

Putnam Investments charges 187 basis points for its Absolute Return 100 Class C shares, according to a prospectus, Morningstar's Burns called the fee "on the high side," vs. about 80 basis points for a typical actively managed fund.

The fund is among four absolute return products Putnam introduced at the start of 2009, and Chief Executive Robert Reynolds said he did not expect to see a return to traditional equity funds quickly.

Investors "got spooked again by what's happening in Europe and the (May 6) flash crash," he said.

Separately, Vanguard Group asked regulators in January to allow some of its retail funds to invest in its Vanguard Alternative Strategies Fund, which employs what the privately held Pennsylvania fund giant calls "absolute return" strategies.

"The fund may employ leverage, derivatives, short sales, and other complex investment techniques or transactions," Vanguard said in its prospectus.

The goal is to reduce volatility, a particular concern for older investors, Vanguard Chief Investment Officer Gus Sauter told Reuters.

"If you're in retirement and you're pulling down money from your account," he said, "it's very tough to recover" from a market downswing.

© 2014 Thomson/Reuters. All rights reserved.

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