Absolute-return funds raise questions of risk

They are being positioned as a way to manage risk, but the push to sell absolute-return funds following…

They are being positioned as a way to manage risk, but the push to sell absolute-return funds following the market crash has some advisers and mutual fund executives worried that investors are being misled.

Fund executives and advisers worry that these funds, which use an array of financial instruments in an attempt to produce positive results in all market conditions, imply a type of guarantee when there is none.

“There is a growing concern at our firm about the term “absolute return,’” said William Glavin president and chief executive at OppenheimerFunds Inc., in a panel discussion at the Investment Company Institute’s general membership meeting, held earlier this month in Washington. Specifically, Mr. Glavin said, he is worried that investors will interpret the name to mean that they “absolutely can’t lose money.”

Concerns about the marketing of absolute-return funds also were discussed at a closed-to-the-press breakfast meeting at the ICI conference, said one fund executive attendee, requesting anonymity.

“These products are being pitched as a simple story to tell investors, but it’s not that simple,” the fund executive said. “Firms are worried about what the impact will be on the industry when these funds disappoint investors.”

That hasn’t stopped the industry with coming out with new funds. Of the 37 retail absolute-return funds, 27 have come to market since early 2008, according to Morningstar Inc.

Advisers have been scratching their heads, trying to figure them out.

“”Absolute return’ is a really good example of a term that no one knows the meaning of,” said R. Alan Moore, a financial planning analyst with Kahler Financial Group, which has $150 million in assets under management. “It’s a catch-all phrase for anything that isn’t fitting into another asset class.”

PRODUCT RESEARCH

As a result, advisers are finding themselves spending more time researching these products to make sure they understand all the nuances.

“There is plenty of historical-return information on long-only funds, but with these funds, there are so many different risk/reward profiles that it takes a lot of work,” said Paul Jacobs, a certified financial planner with Palisades Hudson Financial Group LLC, who is just about to start looking into offering absolute-return funds to his clients.

The increase in such funds is a direct result of a newfound appreciation of risk. Once considered too arcane to discuss, the subject of risk is now front and center — with crash-scarred clients often bringing up the topic themselves.

“We used to have a lot of clients who would just nod their heads when we talked about risk,” Mr. Moore said. “Now they are like, “Oh that’s what you were talking about.’”

The market meltdown and subsequent market volatility have taught clients that equities aren’t the only asset class subject to market risk, advisers said.

“We had a client who was 85% in fixed income and lost 60% of his portfolio in 2008,” said Timothy Knotts, a principal with The Hogan-Knotts Financial Group, Inc. “It was shocking.”

As a result, advisers are able to have much more candid conversations with clients about the possibility of large portfolio losses, advisers said.

Before the market downturn, Mr. Moore would take clients through what-if scenarios that were only moderately bad. “Now we focus on the worst-case scenario,” he said.

Alice King, chief executive of Wine Country Wealth Management LLC, has been an adviser for only about a year, but she makes sure to speak to clients about how much they stand to lose in dollar terms.

“I don’t just say that your portfolio could drop 30%; I put it in dollars,” she said. “Risk has come out of the closet.”

With a growing number of baby boomers entering retirement, the conversation about risk in client portfolios has become as prominent as talk of expected returns, said Tracey Flaherty, senior vice president of government relations and retirement strategy at Natixis Global Associates.

More advisers are putting together “risk budgets” with their clients to determine what their tolerance is and their portfolio allocation should be, Ms. Flaherty said.

Finding the products to help increasingly risk-averse investors has gotten more complicated, since fund companies seem to be launching some type of principal-protection fund or absolute-return fund every week, executives said.

PUTNAM EMBRACED FUNDS

Putnam Investments, which launched its absolute-return series three years ago, doesn’t see a problem with the branding.

“We never named these products; the names came from the institutional space,” said Jeff Carney, head of product marketing, adding that Putnam sells the funds exclusively through advisers.

When Putnam launched the funds, it spent a lot of time on roadshows and meeting with advisers to make sure they understood the products, he said.

“I think the criticism is due to lack of education,” Mr. Carney said. “The second-guessers are the ones that don’t have the ability to launch these products themselves.”

But some advisers, such as Mr. Knotts, are staying away from absolute-return funds, seeing them as the latest product du jour.

“We see this every time the market declines — all this stuff comes out promising something that solves the last battle,” Mr. Knotts said. “I’m just not buying it.”

E-mail Jessica Toonkel at [email protected].