Nothing absolute about 'absolute return' funds

Paul J. Lim is a senior editor at Money Magazine. Email him at plim@moneymail.com.

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(Money Magazine) -- After two of the worst bear markets in history, you're probably craving reassurance. Well, the mutual fund industry is hungering to give it to you.

You may have noticed that several investment firms have introduced funds whose goal is to make money regardless of how the stock and bond markets fare -- and with lower volatility than traditional funds. There are now 21 of these " absolute return" funds, up from two in 2004. But you have to wonder: If such a strategy works, why weren't companies pushing it before the bear?

"This is classic Wall Street," says Greg Schultz, a Walnut Creek, Calif., financial planner. "After the fact, let's make up a product that people wish they had owned."

Aside from the suspicious timing, the real problem with these funds is that there's nothing absolute about them, except the killing that the fund companies make. Fees average 1.6% of assets and often exceed 2%.

For that kind of payout you might expect in return some sort of guarantee that you'll make money in good times or bad. Or insurance against losses in any year. But most of the funds that were around at the start of 2008 lost money for the year, including UBS Absolute Return Bond (down 23.1%).

The funds' stated goal is simply to achieve a positive result over a reasonable period, which could be as long as several years. (Putnam's funds shoot for a specified return over Treasury bills.) But doesn't every investor seek to make money in that time frame?

Another issue is that "everyone has a different view of what it means to manage money in this fashion," says Lipper's Jeff Tjornehoj. Funds such as Western Asset Absolute Return are bond alternatives. Others, like Putnam Absolute Return 700, aim for equity-like results.

In terms of strategy, some are long-short portfolios, which means they're allowed to invest in stocks but also bet against them. The managers of Putnam's offerings are free to go almost anywhere; they can invest in assets from blue-chip stocks to junk bonds to currencies. And many absolute-return funds use derivatives and leverage to try to protect you. "You really have to look under the hood," says S&P's Todd Rosenbluth.

If reducing risk is your aim, there's a simpler, cheaper way. It's called asset allocation. Cut risk by investing more in bonds. Will that guarantee you won't lose money? No. But neither does Wall Street's latest high-priced solution.