Imagine a new mutual fund with the appealing name of “No-Worries”. It might get your attention. You might look to the mission statement and find some suggestion that upon investing you would not be guaranteed anything because investment involves risk.
But on the other hand, you will have nothing to worry about, your money is safe, and your retirement is practically assured. We call this market neutral and the appeal is growing. Only instead of our fictitious name, these funds might find the descriptive of “Absolute” better suited for the serious investor.
So what are absolute funds and how do they make such bold promises? In another incarnation, they might be called hedge funds.
For the average investor, the entry fee into this elite investment group is too costly, not just in minimums needed to invest but also in the cost of management. So absolute funds were created as an alternative in regulation only.
They are allowed to bet both sides of the coin. the dark side of the bet includes the use of options, futures, currency hedges, or the bet that certain stocks will lose their value, a strategy called short selling. The bright side of the portfolio, or should I say the more conventional approach involves buying stocks and bonds.
The thinking is, as one half of the portfolio reacts to the marketplace, the other will react in an equal and opposite fashion. It is an investment balancing act that suggest to the investor, and there are $7 billion on newly invested money assuming this scheme will work for them. In fact, you will have to actively hunt these funds down, culling the 21 available at current count from the hundreds of mutual funds who use some limited use of the strategy. So they may not, in their purest from, be available inside your retirement plans at work.
You should probably avoid them if they are for two reasons. Investors vote with their feet. And if these funds don’t deliver – in other words create the worry that they were supposed to relieve – then these funds will have a great deal of difficulty satisfying these investors. This is not the case with hedge fund investors who have a window in which to sell and it may not be at the most opportune time. Keep in mind, investors who flee put additional pressures on those who stay. Not only are there fewer actors involved, the taxes that could result from the sale of profitable investments to pay those leaving will need to be paid, often months later.
The second reason is wholly market based. Absolute funds can lose money. Numerous market analysts are warning that these funds will not do well if the stock market suddenly turns on a solid bull run. Like hedge funds, the investment bets placed need time to develop. Should the market move suddenly in either direction, the timeline needed to execute the plan would either be shortened (if stocks fall) or lengthen (if they rise). Either way, they need to keep their money involved.
So why seek these funds at all? Is it because balanced funds are boring? Is it because investors want to pay for the risk that is sold as neutral, often topping 1.8%? Is it because they believe that interest rates won’t ever go up (absolute, equity long-short and market neutral funds all have huge exposures to Treasuries and other interest rate sensitive investments)? Is it because losing in an up market is better somehow?
Balanced funds are boring. Index funds are somewhat so. And bond funds may be headed towards a bubble – or not. But those risks or lack of them still make the promise that losing money is simply not possible with a fund name like Absolute does sound too good to be true. And you would be right.
As long as investor recognize the “tell me what I want to hear” pitch as just a pitch, as long as we look well past the name and the promise, and delve into the potential (only amateur gamblers ever make decisions on probabilities), they will avoid these funds. But perhaps that isn’t what you want to hear.
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