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Absolute Return Funds Control Risk

Stocks in this article: AARFX FMLSX DAMDX NARFX

NEW YORK ( TheStreet) - Seeking to attract nervous investors, fund companies have introduced a wave of absolute return funds. The new funds aim to produce positive returns nearly every year.

Recent entrants include Eaton Vance Option Absolute Return Strategies (EOAAX), GRT Absolute Return (GRTHX), and Loomis Sayles Absolute Strategies (LABAX).

Fund tracker Lipper recently began reporting data on the absolute return category. During the three years ending in 2010, the category outdid the MSCI World Index, says Gabriel Burstein, global head of investment research for Lipper and Digital Ventures. "The absolute return funds have helped to control risks," he says.

The funds follow a wide range of strategies. Some sell stocks short, betting that prices will drop. Others aim to limit the downside by holding a wide range of securities, including futures, commodities and bonds.

Portfolio managers disagree about the definition of absolute return funds. Some managers say that all funds with long and short positions should be included in the category. According to Lipper's definition, absolute return funds aim to outdo a benchmark by a fixed amount. For example, Putnam Absolute Return 300 (PTRNX) seeks to surpass Treasury bills by 3 percentage points.

The absolute return funds typically aim to achieve positive results even in years when stocks and bonds are falling. In contrast, many conventional funds don't necessarily aim to avoid losses. If the market drops 10% and a conventional fund loses 8%, then the portfolio manager is considered to have outperformed.

While the absolute category's overall returns have been competitive lately, investors should shop carefully because the results for individual funds have varied considerably. For every fund with promising results, others have proved extremely disappointing.

Some funds have lost money consistently. Among the laggards is Nakoma Absolute Return (NARFX), which has been in the red for three years running. Dunham Monthly Distribution (DAMDX) has made money in two of the last three years, but it has lost 0.3% annually during the past three years, trailing the S&P 500 by 2 percentage points.

Many absolute return managers seek to achieve difficult goals -- and they have failed to accomplish the task, says Nadia Papagiannis, a Morningstar analyst, who follows absolute return hedge funds and mutual funds. It is very hard to lower risks in downturns and produce competitive results in bull markets, she says. Of 870 absolute return hedge funds tracked by Morningstar, 85% lost money during the downturn of 2008. "Funds don't always provide downside protection when investors need it most," says Papagiannis.

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