Weekly Update – March 19, 2010

So I recently spent a few days on the road engaged in a due diligence mission.  After a lot of changes over the past year, one of the major mutual fund families invited a group of investment advisors (the folks who sell their funds to clients) to come by HQ and kick the tires and visit with many of the new PM’s and execs that have come on board this particular fund family over the last 18 months.  All in all, it was a very well-organized trip.  Extremely well done.  This fund family remained on point and on message throughout the visit.  Not a lot of stones were left unturned.  This fund family showcased a lot of investment talent to the gathered visitors.  A succession of very impressive people hit the stage.  Many of these folks were industry heavyweights.  After a very mixed performance over the last 10 years, my guess is that this fund family is very well positioned for the future.  It shall remain nameless since I don’t do public recommendations.

But part of me remains uneasy.  One of the main topics of discussion during the visit focused on a particular fund strategy that this firm, along with many other fund families, has recently brought to market.  The investment strategy has been described in various terms and in various ways, with “hedged equity”, “real return”, “absolute return”, and “multi-strategy, multi-asset class” being among the most prevalent of the adjectives.  This category of funds (including ETF’s) is among the fastest growing of all new strategies coming to market.  The ETF pipeline is currently bursting with vehicles scheduled to go public over the next 6-9 months that are expected to employ strategies like the ones described above. 

So why am I concerned?

Many of these funds have expressed in some form or fashion that they expect to employ an “absolute return” investment strategy.  Thats all fine, except for one thing.  “Absolute return” is not a strategy, it’s a return target.  And most of these new funds have specific return targets.  In some cases, extremely specific.  The problem is, the capital markets don’t work that way.  Simply publishing a return target in advance, even if it is a relative return target, doesn’t necessarily mean that the capital markets will provide the opportunities to generate returns up to that intended level.  Maybe they will, maybe they won’t.  The point I am trying to make is that investment strategies aren’t necessarily repeatable year in and year out.  Sometimes they work, sometimes they don’t.  It’s the nature of the beast.  Promising a return in advance to investors is dangerous, if not downright silly.

Make no mistake.  My view is that the future belongs to multi-strategy, multi-asset class investment vehicles and approaches.  Highly rigorous, highly methodical, highly diversified, and highly risk-managed total portfolio investment solutions are in (and likely to remain) the sweet spot given the dynamics of the current capital market environment.  A lot of fund families are bringing vehicles of this type to market.  It will soon become a tidal wave.  Some will thrive.  Most will fail.  But by no means are all these vehicles created equal.  Many of them have been crafted by slickster marketing types seeking to garner as much of the fund flow to this category as possible.  And when you peel back the marketing hype and peek under the hood to see what many of these funds are actually doing with the assets entrusted to them, its cause for concern.

So, be careful out there.  Don’t just read the label.  Do your homework.

Stay tuned.

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