An Investor's Best Protection: Understanding
Now, the ranking really aims to report the funds with the best returns adjusted for volatility. In theory, this seems a perfectly fine thing to study -- it tells us which funds have historically offered a higher return with a smoother path. Problem is, volatility isn't the same thing as risk. Moreover, the "riskless" moniker doesn't reflect how the funds actually invest.
Case in point: The fund placing first in August 2012's report was a bond fund composed largely of government bonds. It may have had fine returns (though what to measure that against is a matter not discussed in the "Riskless Return Index"), but there is no way to really see the fund as "riskless." At bare minimum, it's subject to interest rate risk. As interest rates rise, bond prices tend to fall.
But in this specific case, the trouble doesn't stop there. You see, this so-called "riskless" fund used a heavy dose of leverage to achieve its outsized returns--the very opposite of "riskless." In fact, leverage increases risk--it magnifies volatility and potential declines. As of June 30, Morningstar reports the fund was 178% invested in bonds, meaning you're actually making a substantial bet on interest rates' direction.
While we don't expect rates to surge higher in the near future, the fact long-term bond rates are at or near generational lows suggests the longer-term trend ahead is likely higher, not lower (see Exhibit 1). That makes the "riskless" label especially dubious at this juncture.These are merely two examples of many where unclear communication and complexity could work against you as an investor. Ultimately, Vice President Ek's comments at the top -- delivered recently to an audience at our headquarters -- highlight an important point for investors: The only real way to arm yourself against flawed strategies and products is understanding. If the product is too complex to yield that, our suggestion is to keep looking. This article was written by an independent contributor, separate from TheStreet's regular news coverage.
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