In the last decade, and in particular, the last few years since the end of the 2008-09 financial crisis, a lot of investment product has been created with some variation of the moniker "absolute return." The idea of absolute return is a bit ambiguous and might catch the unsuspecting investor, eager for some sort of guaranteed and safe return in today’s uncertain climate, a bit unaware.
The word absolute almost implies a guarantee, and the idea of return implies profit, creating the idea of a guaranteed profit from these vehicles, which are usually structured as mutual funds. However, as most investors are aware, true guarantees can only be made by someone who owns a printing press and the authority to print money. In other words, governments are the only true guarantors, and many of these may presently be viewed with skepticism as to the quality of the guarantee.
That doesn’t mean that absolute return funds aren’t worth considering, but investors should have both eyes wide open and understand the objectives the fund’s management team will pursue on its behalf. We won’t be naming any particular funds in this article, but rather will be reviewing the different concepts or camps that absolute return managers can be grouped into.
The first group is those who try to achieve positive results in each and every year. These funds will tend to have lower levels of volatility and returns over time because to produce a positive result each year, you cannot take the risk of being wrong on the direction of the stock market or other more volatile asset classes that might produce large returns, but come at a price of more volatility and uncertainty over short periods of time.
It is important to note that there are two ways to measure return. One is absolute meaning that the success is measured against zero. The results are either positive or negative and easy to measure. Other funds gauge their results against a benchmark, which is usually an index of stocks, bonds, or other investments which the investor could alternatively buy instead of the fund in question. These funds are generally measuring their results in a relative sense. This means that if the benchmark index goes down 6 percent in a particular year, and the fund only went down 3 percent, they would consider that a victory.
We have a saying in the investment business that goes like this. You can only eat relative returns for so long. If an investment vehicle generates negative returns that are less negative than a benchmark that is going down over time, you are still losing money. This is where we get to another important distinction in funds which pursue an absolute return mandate. The additional concept to consider is that of impairment of capital. There are two kinds of impairment – permanent and temporary.
Permanent impairment of capital occurs when a security becomes worthless or when the loss of value is so large that the time and magnitude of returns required to recover make the impact on your wealth a permanent impact.
Compare this to the concept of temporary impairment. In this case, the stock prices of a high quality company may go down, perhaps substantially due to investor fears, but the company is meanwhile still selling as much or more of its product as it was last month or last year, and its profits and dividend payments to shareholders continue to grow.
Generally, in some short period of time, the stock price will recover and go on to new highs. We’ve seen this in the last few years when stocks tanked during the financial crisis, but it proved to be a good buying opportunity for these higher quality corporations, many of which are now hitting new all-time highs.
Some funds which consider themselves absolute return managers do so with a longer time horizon in mind and are not panicked if one particular year ends up being a slightly negative return. Their goal is over slightly longer periods, say 3 to 5 years, to generate positive returns by buying undervalued assets that others are selling and to do so with lower volatility than the markets in general. However, the volatility may be higher than a fund with a goal of generating lower returns with low levels of fluctuation along the way.
Both types of funds have a purpose in different parts of a portfolio and for investors with different objectives. Rather than be taken in by the words absolute return at face value, I suggest doing a little homework as to the characteristics of the fund you are considering.
Tom Breiter is president of Breiter Capital Management, Inc., an Anna Maria based investment advisor. He can be reached at 778-1900. Some of the investment concepts highlighted in this column may carry the risk of loss of principal, and investors should determine appropriateness for their personal situation before investing. Visit www.breitercapital.com.