blog
Outcome Oriented Funds
by Steven
My last couple of days at the NICSA annual conference got me thinking about the viability of 40 ACT absolute return products.
Many baby boomers who thought that they were well diversified have seen their retirement goals slashed or erased by the current financial crisis. This has triggered distrust among investors towards traditional investment approaches causing assets to move into low-return cash-equivalent investments. Some asset managers are responding by providing investors with outcome-oriented products that mitigate risk, generate income, protect principal, and/or guarantee at least modest returns.
This year's NICSA conference was filled with heated debates on how to tackle the current financial crisis. In his keynote address, Philipp Hensler, CEO of DWS Scudder Distributors, pointed out that the nine Morningstar boxes are too highly correlated to provide sufficient diversification for investors to sustain the current drop in the financial markets. A theme emerged around the importance of using product innovation to better accommodate the changing landscape. The financial environment has changed and investors are now realizing that they were not sufficiently diversified.
Some firms have responded to the lack of protection via the Morningstar box diversification by creating 40 ACT products that move away from relative to absolute performance. Unlike relative return funds, which measure themselves against market indexes, absolute-return funds are designed to always produce a positive return regardless of the directions of the market.
Two examples of funds that fall under this category are:
Putnam's Absolute Return Funds is a family of target absolute-return funds that seek annualized total returns of 1%, 3%, 5%, or 7% above those of Treasury bills over a period of three years or more. The funds include two global bond funds and two multi-asset funds.
DWS's LifeCompass Protect Fund is an asset allocation fund with a10-year maturity that is designed to protect principal, limit down-side risk, and lock in gains on a daily basis. At maturity, shareholders will be able to redeem shares at the highest NAV of the fund. Different from Putnam's product, DWS has an actual guarantee that they are able to fulfill through a third party financial warranty. The warranty assures that shareholders will receive an amount that is at least equal to the highest NAV on the maturity date. The fund utilizes an enhanced constant proportion portfolio insurance ("CPPI") investment strategy in managing the fund.
These products have clear advantages:
- The investor can plan their retirement around these products because of their certain outcome
- Fees tend to be much lower than hedge funds and lower than variable annuities
- They fall under the same strict compliance rules as traditional mutual funds
Actively managed mutual funds will not be able to survive in this market environment if all they are able to do is outperform their competitors in a style box, but still manage to lose their investors money. The mutual fund industry needs to go the direction of absolute returns in order to combat low cost ETFs, as well as annuities.