Absolute-return investing is an innovative strategy because it focuses on pursuing returns while still managing risk.
As a result, an absolute-return strategy takes a different approach than traditional strategies, which are based on broad exposure to stock and bond markets. While these traditional strategies historically have helped investors build wealth over the long term, they also expose investors to significant market volatility and periods of negative performance.
The fundamental goal of an absolute-return strategy is different — rather than trying to outperform a traditional benchmark of stocks and bonds, the strategy pursues positive returns with less volatility over time, no matter what is happening in financial markets.
Freed from traditional market benchmarks, an absolute-return strategy can invest in a wide range of securities, use modern risk-management tools and dynamically adjust its portfolio as opportunities and risks change.
An absolute-return strategy focuses money managers on investors' elementary concerns — achieving a positive real return, one that enhances their purchasing power. This strategy is attractive today because of the nearly unprecedented challenges that financial markets face.
In the wake of the financial crisis of 2008, and with the economy in recession, investors have a stark disparity in choices. Conservative investment options such as savings accounts, money market funds and many short-term securities offer very low returns — one-year Treasury bills yield less than 1%.
By contrast, there are many stocks and bonds whose values fell sharply over the past year. They appear to offer attractive potential for long-term returns but will remain volatile for some time.
Between these two extremes, there is little available in terms of an investment that offers a moderate return with tolerable risk. An absolute-return fund can fill this gap because it can target a combination of safe and more volatile investments, and it has the flexibility to favor attractive securities while using other tools to manage market risk.
An absolute-return strategy grants greater freedom for money managers in three main areas of investing.
First, the strategy typically invests in a wider universe of securities so that they aren't limited to one sector that can fall out of favor.
For example, a bond manager who can invest in either high-yield or mortgage-backed securities has a better opportunity to generate positive returns more consistently over time than a manager whose choice of investments is limited.
Along similar lines, some absolute-return strategies can also have the freedom to invest across asset classes, including stocks, bonds and alternative investments. This type of strategy is most effective in the hands of a manager with a seasoned asset allocation model to determine which areas have the most attractive balance of risk and reward.
This flexibility allows the manager to benefit from the increasing diversification of financial markets, by combining investments that have low performance correlation.
Absolute-return strategies can also have geographic flexibility to invest outside domestic markets. When it comes to stocks, the United States is the largest market, but international stock markets represent a majority of the world's securities, as measured by the MSCI World Index.
Many of these markets, particularly in Asia, have offered stronger rates of economic growth than the United States. Fixed-income markets outside the United States also have evolved to offer a wider range of opportunities in recent years.
With global flexibility, absolute-return strategies can pursue the most attractive investments anywhere in the world.
Finally, absolute-return strategies can use modern risk-management tools, such as futures, forwards and options, to gain exposure to specific markets, to fine-tune portfolio strategies and to mitigate unwanted market risks. For the purpose of an absolute-return strategy, the attractive feature of these tools is the ability to reduce risk by hedging against market declines.
In light of the market declines, many investors are re-examining their assumptions and considering their portfolio options. Given current investment opportunities, it is an attractive time to benefit from the flexibility of an absolute-return strategy and its tools for managing risk.
Rob Bloemker is portfolio manager of the Putnam Absolute Return 100 Fund and the Putnam Absolute Return 300 Fund, offered by Putnam Investments of Boston. Jeff Knight is portfolio manager of the Putnam Absolute Return 500 Fund and the Putnam Absolute Return 700 Fund.
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