Absolute return is just a marketing term: Morningstar

Global research firm Morningstar is urging caution among retail and institutional investors alike amid a revival of interest in absolute-return-style strategies to counterbalance market volatility.

“We believe that absolute return is not a categorisation, it is a marketing term,” states Chris Douglas, co-head of Australasian fund research at Morningstar.

Uncertainty over the future direction of the global economy has driven secondary market volatility on the back of the 2008 global financial crisis, sparking renewed demand among investors large and small for absolute return.

Absolute return is the (broken) promise of the hedge fund community. The aim is to mitigate downside risk, although as Douglas points out, investors would be wrong to assume positive returns in all market conditions.

Institutional demand can be seen from the fact that the hedge fund sector attracted $116.2 billion globally in the first six months of 2011 – the strongest half-year asset flow on record, according to data provider Eurekahedge.

Further, since the end of 2008, more than 700 absolute return funds have been launched (primarily targeting retail and high-net-worth investors) and this trend is gathering pace, according to Morningstar data – which Douglas admits is inexact owing to the strategy’s broad nature.

But tellingly he points to a precedent. After the Black Monday stock market crash of 1987, many funds were also struggling to perform and absolute return-style strategies subsequently became all the rage, notes Douglas.

But he points out that many post-1987 absolute return funds proved to be overly bearish and ended up lagging fully invested funds looking to participate on the upside.

“Thinking there was going to be a market correction, a lot of investors ended up on the wrong side and from a capital preservation point of view they lagged a lot of the more fully invested funds that were looking to participate on the upside,” he explains.

“From a marketing perspective, absolute return is very easy to sell. It’s something that people can really feel more comfortable about investing back into the markets. But, if anything, that’s a reason to be wary about investing in these products.”

Douglas notes that today’s absolute-return strategies rely less on a traditional balanced approach (equities, fixed income, property, infrastructure and cash) and more on a macro-based allocation that invests according to prevailing conditions over a period of six months to a year.

“We all know trying to call markets is incredibly difficult,” he adds, citing the fact that the US equity market was among the world’s best performing last year, and China among the worst – a reversal of prior expectations.

“I believe now more than ever investors need to do their homework, and that includes sophisticated investors who are not immune from making the same mistakes that the average mum and dad investor makes,” adds Douglas.

Along with absolute return, Morningstar data shows almost 550 multi-asset funds have been launched since the beginning of 2009 – further evidence of the post-2008 demand for risk diversification.

Douglas notes that some fund houses construct balanced portfolios using risk management, tactical allocation and review monitoring and says this type of outsourced management can make a lot of sense for the average investor.

“But when anyone comes across a new style of fund offering, their first reaction should always be slightly cynical," he notes. "Why has this been brought to market now, and how does it stack up from an investment point of view?

“If it doesn’t have a track record, how can I assess how it will perform in different market conditions? You need to find your comfort level knowing that investors won’t be foresellers of these funds, which is the biggest danger.”

He points out that simplicity is the one factor investors are seeking, to invest in funds they understand as opposed to the complex derivative products that became popular in the 2000s.

“We are hearing more and more clients say to their fund manager: ‘I don’t care so much about the benchmark, I care about getting lower volatility. I want to be able to move to cash if market conditions are deteriorating, but at the same time I want you to make more of a macro call.'”