A reader emailed me yesterday thanking me for my overview of the ins-and-outs of absolute return funds, but wondering if I knew where they’d all emerged from.
As a long-time UK investor, “N.W.” said he’d heard similar promises from funds before, but he’d been struck by how both the term “absolute return fund” and advertising for such funds had proliferated in recent years.
Why, he asked, couldn’t he now open a copy of The Sunday Times Money section without seeing an advert for such a fund?
Absolutely the wrong time to play safe
The short answer is there’s a lot more absolute return funds about.
Recent-ish changes in European legislation is one reason why – conventional fund managers were previously not easily able to short shares, or to use other strategies absolute funds employ, such as derivatives.
But with the financial services industry, it’s often better to first look at how a product meets the company’s need to make a profit, rather than ask what it can do for us, the customers, which usually comes a distant second.
And with absolute return fund, in my opinion the reason we’ve seen so many around recently is that the big stock market falls made them easier to sell.
According to The Guardian in an article of March 1st 2009:
Half of the 20 funds in the sector have been around for less than a year, three have been launched in the past month – by SVM, Gartmore and Argonaut – while Pictet has said it is planning one and a number of other fund managers are considering joining the fray.
So reader A.N.’s perception is quite correct: There were plenty of new absolute return funds launched in 2008 and early 2009.
And sure enough, here’s the real reason why:
With stock markets down 40% in the past year and some pundits predicting further falls, it makes sense to launch a fund that claims to be able to make money for its investors even when share prices are falling.
So there’s our answer. But I say it makes no sense.
How does Warren Buffett put it? “Be greedy when others are fearful”.
Regular readers may remember almost to the same day in March as this Guardian report, I was suggesting the markets were a bargain:
Cash is yielding less than 1%. Government bonds are probably still in a bubble. Property prices continue to fall. Corporate bonds do look cheap but if they recover then equities will probably do even better.
Meanwhile, the global stock markets have suffered their worse declines for several generations.
Ultimately, if you’re not trickling money into the markets at these levels then I think you might as well forget stock market investing altogether.
Admittedly I’d bought on earlier dips and I certainly won’t claim I foresaw the rapid market surge since then. I just knew shares were much cheaper than they’d been for years, and in the long-term were likely a good buy.
The other half of Buffett’s famous maxim is “Be fearful when others are greedy”.
If there’s a time to move into absolute return funds, it’ll be after the market has gone up 100%, not after it’s dropped 40% as The Guardian article suggested. Since then the FTSE 100 has risen as much as 50%.
An absolute return fund is for life, of course, not just for Christmas.
While theoretically their investors should be happy their 15% or whatever is in the bag (their managers will certainly be happy to trouser some of the excess), human nature means many bear market bottom investors in absolute return funds are probably praying for another crash to justify their decision.
6 Comments
Interesting. I think Warren’s point is quite important. If we follow the advice of the common man, then we are likely to get average results. But when we consider the thinking of the most successful people, it makes it possible to achieve outstanding results.
In addition to your call to be greedy when others are fearful, I think it’s possible to use risk management techniques–portfolio sizing and stop losses–to optimize that strategy.
Markets tend to rise. If it’s so difficult to make money (by a long fund) think how difficult it will be for a fund manager who also must short.
Forget it. Shorting is something very few can do profitably. This is purely a marketing ploy. The funds know they suck, they just want to sucker some investors….FWIW
@Neal – I agree, and have very rarely shorted anything. I think bearish private investors who want to trade are better off selling where possible and going to cash, though I appreciate that tax, costs, and other concerns can complicate matters.
Somewhere in the middle of the bear market I did wonder whether as someone who dabbles in stock picking I should try to short the market, go long my picks, and pocket what financial types call the ‘alpha’ – the difference my stock picks make to returns. But as my head says a tracker would be better and my stock picks are likely to under perform – and as and my stomach would lurch at the leverage required to generate equivalent returns – I’ve shelved the idea again. 🙂
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And with absolute return fund, in my opinion the reason we’ve seen so many around recently is that the big stock market falls made them easier to sell.
I entirely agree that this is the reason for the recent popularity of Absolute Return funds.
What Buy-and-Hold advocates miss is that it was the stock market gains we saw in the 1980s and 1990s that made Buy-and-Hold strategies popular. It works the same way at both ends. We had 20 years of promotion of one irrational idea and we now are in the early years of promotion of an idea that I think can fairly be described as equally irrational in the opposite direction.
The Buffett quotes point us in the direction of rationality, in my assessment. When everyone else is greedy, be fearful, and when everyone else is fearful, be greedy. When everyone else believes in what the Buy-and-Hold people say, check out what the Absolute Return people say; and, when everybody else believes in what the Absolute Return people say, check out what the Buy-and-Hold people say.
It’s the emotional extremes that you want to avoid. What makes it hard is that all this stuff has to be marketed and marketing pitches always focus on the emotions. That’s so whether the thing they are selling is Buy-and-Hold or Absolute Returns.
Rob