But not all advisors have been seduced.The study of absolute return funds might be likened to quantum physics. Just as you can't determine a particle's momentum and its position at the same time, you also can't tell which way absolute return funds are going by their relationship to traditional funds or benchmarks-or even to each other.

That's the not-so-complimentary view among critics and, increasingly, the media. But the trend will not be stopped, and a slew of these funds are hitting the shelves anyway (there are 101 funds classified as "absolute return" in Lipper's database. Eleven of these have launched just this year, says the company, and only 16 or so have been around long enough for five-year track records). Morningstar despairs altogether of creating a category since these funds all pursue such radically different investments. Instead, the Chicago fund monitor shunts varying absolute return funds into such categories as "nontraditional bonds" and "long-short" categories.

Critics put it more acidly: "They're black boxes. No one knows what they're getting into," says financial advisor Robert Schmansky, the founder of Clear Financial Advisors in Bloomfield Hills, Mich. "The idea behind these funds is that they can turn over their entire portfolio strategy on a dime. So while we're looking at what appears to be a solid, backwards-looking strategy, tomorrow's strategy could be something entirely different." He also believes many of the companies hawking these products now were poor performers to begin with. "Some of them were at the core of the mutual fund scandals," he says.

Liken the absolute return idea to a Disneyland ride. While everybody else in the market rides a stomach-churning Space Mountain roller coaster, absolute return funds aim to slowly rise above cash-offering a smooth funicular cable car trip up the mountain, as well as buoyancy when everything else is crashing into the river. Lipper refers to them as "mutual, pension or insurance funds that aim for positive results in all market conditions." They only have to do better than cash. 

But that's just a goal, not an asset class, which is why so few absolute return funds look alike. Pimco launched one last year with investments in global credit sectors. Eaton Vance has five different funds, pursuing varying ideas from global macro to methodical option sales of the S&P 500. The Dreyfus Global Absolute Return Fund invests in global equity, bonds and currencies through long and short holdings in options and futures and forward contracts.

Because managers in these funds can go anywhere and often short securities, these are sometimes called poor man's hedge funds-or worse yet, marketing stunts, offering a promise already inherent in a cheaper, simpler, less-opaque asset: a bond.

"Absolute return as a starting point, it's a goal, it's not an investment asset class or investment type, so there are a lot of ways of going at that goal," says John Rekenthaler, head of fund research at Morningstar Inc. in Chicago. "What's more, it's a fuzzy goal. Because it's not achievable, technically. If we take absolute returns to mean making a profit every month, or even every quarter, you can't do that with risky assets. If you really want absolute return, you buy Treasurys. None of these funds do turn out a profit every month in a row or every quarter. The only way to do that, besides being in Treasurys, is to have Madoff next to your name."

He says that if you compared these funds to more traditional styles, they often come up short. He takes for example two Putnam funds, the Absolute Return 500 and 700 funds (named for their basis point targets over cash). While the 700 fund's appealing three-year return of 6.4% (as of late July) bests cash and maybe even other absolute return strategies, it wouldn't beat the typical 60/40 fund in the past three years, which on its stock/bond wings falconed back with 11% annual returns, he says.

Critics have, incidentally, called Putnam's marketing strategy questionable-of a 100, 300, 500 or 700 basis point return over cash, why wouldn't investors simply go with 700, asked advisor Dan Moisand of Moisand Fitzgerald Tamayo LLC in a Financial Advisor online column (not mentioning Putnam by name). The idea seems gimmicky, critics say, and reaffirms their worst notions of the whole category.

"Advisors need to seriously assess how likely it is that the potential result [of these funds] will be good enough to overcome the added complications, added risks, added costs, tax inefficiency etc.," Moisand added in an e-mail interview. "We think it is downright unlikely."

Indeed, of those funds that have been around five years, barely half have had positive performance in that time, according to the Lipper database of absolute return funds.

Don't Let Me Be Misunderstood
And yet, despite the doubts, the absolute return idea has defenders both inside and outside the fund industry. Michael Abelson, the senior vice president of investments at Genworth Financial Wealth Management in Pleasant Hills, Calif., is a proponent of the concept, which Genworth uses as one in a number of strategies, employing the help of various outside mutual funds.

"As we define these strategies," he says, "they tend to have less correlation to stocks and bonds."

Gene Goldman, head of research at Cetera Financial Group in Los Angeles, says that after the tech bust in 2003 he was approached at a conference by an advisor sick of churning markets, and sentiment was gathering even back then for a product like this one that hit risk head on. "We do believe you want to have an absolute return strategy within your recommended fund list," Goldman says-something besides long-only managers parochially sticking to certain asset classes.
Still, Goldman concedes that there's lots to dislike about the category. Part of the problem, he says, is that investors move into these products too late-usually after a crisis, when they are likely going to miss big returns in the traditional "relative return" funds. Rather than dollar-cost averaging into them, people are likely buying in a panic when the market swoons-zigging when the market is zagging-"especially if you look at post-2008. A lot of absolute return funds were created after the 2008 period," he says.

Besides that, he adds, many of them are vague and hard to analyze, since a lot of them use derivatives. "You're not sure about the experience of the underlying management teams. They also tend to trade a lot, so you've got capital gains potential." And despite their vaunted diversification promises, many of them are highly correlated to the stock market anyway, Goldman notes.

And none of that takes into consideration their high expense ratios. A brief glimpse across Morningstar's universe shows that the 36 funds carrying the absolute return name, with few happy exceptions, often charge expense ratios north of 1%. More than half charge north of 1.5%, and in extreme cases more than 2%. That eats into returns that are already pretty unambitious.

Fund Approaches
Given the variety of approaches, maybe it's not surprising that Eaton Vance, an early entrant into this category, has five funds and four wholly different absolute return styles itself. Says Brad Godfrey, a company vice president and institutional portfolio specialist, "We have a pretty substantial lineup, including one that has been run since 1997. It's definitely an important part of our business here."

Godfrey names two reasons such funds are important: one is all the volatility in the market since 2008, and rising correlations between other securities. The other is that the market's response to the financial crisis has been to bid up safe assets, so the yield from a 10-year Treasury is not attractive-only 1.5% or so. And with inflation at long-term averages of 2.5% to 3%, he says, "now all of a sudden you're looking at negative real yield-or yields adjusted for inflation-across the U.S. Treasury yield curve to 20 years." This isn't to mention the risk bonds face if interest rates rise, in which case "safe" Treasurys are liable to get creamed.

One of the company's approaches is a global macro strategy it pursues in two funds. Gene Goldman says his firm Cetera holds this fund and likes it. "This fund focuses more on a global macro perspective," Goldman says, "also looking at the political environment. I think this is a great way of increasing diversification within an equity portfolio, because most equity long-only managers tend to be very bottom up. [The Eaton Vance fund focuses] on earnings growth, they focus on revenue growth. We want a manager that's doing something opposite to what the bond managers are doing."

Eaton Vance also has a multi-strategy absolute return fund that makes tactical allocation choices, seeking to reduce risk exposure but also find alpha in a variety of securities. And there is a strategy that Godfrey calls an arbitrage approach to S&P 500 options.

"That particular strategy is all on the S&P 500," Godfrey says, "So we sell options, we sell a call and sell a put out of the money, and basically the funds earn the premium income that you earn from selling those and then we sort of risk-manage the strategy. It buys back a call and a put further out of the money, and so you basically cap your loss on that position and you basically hope the options expire worthless and you keep the premium income. Over time, we sort of do that on a small piece of the portfolio every few days, but we stagger the dates and so the strategy basically resets itself to market levels."

The firm also has a market neutral strategy. But why are these better than investing in Treasurys? "A few very important components to any absolute return strategy is that one, you don't have a stated benchmark. ... In addition to the market-based benchmark, it's important that you have the ability to short. If you're able to isolate exposures by investing long in one asset class and short in another, that really gives you more flexibility and sets you up for a better chance of success."

Putnam Investments in Boston formally christened its absolute return array for advisors and retail investors in early 2009 after enjoying some success with the strategy in the institutional space. To Jeffrey Knight, the head of global asset allocation at Putnam, the need was apparent because there seemed to be no middle ground risk level between the safety of cash and the high standard deviations of other assets.

"We thought the world was changing," Knight says. "Tethering yourself tightly to the market was a recipe for low returns and high variability." He says that the problem with comparing these funds to benchmarks is that people are measuring alpha, not risk.

"Morningstar has no expertise in this area, and I'm not surprised they can't make any sense of it," says Knight. "The whole point of this approach is that it doesn't fit squarely alongside an existing roster of investments."

Knight says these funds require a different battery of metrics to observe-ones that focus on the confluence of risk and reward. "We need to develop statistics that allow for reasonable inference about whether you're doing any good. First it would have to be the Sharpe ratio," he says. "It does come down to comparing your performance to cash, but the goal of the absolute return investor it seems to me is to deliver positive return over cash as efficiently as possible. So we want to compare the excess return to cash to the volatility taken to generate that excess return."

Putnam's four funds, the 100, 300, 500 and 700, take slightly different approaches. The first two ply their trade only in fixed income while the 500 and 700 funds can invest in global equities in addition to mortgage backed securities, junk bonds, commodities, REITs and credit replication indexes. "We have to think about the portfolio holistically, so it's not just the characteristics of an individual holding but also the way that individual holdings will interact with other parts of the strategy," Knight says.

What about the criticism that everybody would strive for 700 basis point returns, which makes the Putnam categories look like marketing schemes? Knight says that the focus should be on the risk the investors are taking, not returns.

"The returns obviously are not guaranteed; they're targeted returns," he says. "So there is a spectrum across which the risks go hand in hand with the targeted return. The reason why we picked 100, 300, 500 and 700 is because those are the excess returns that in long history corresponded to the neighborhoods of risk appetite."

Godfrey and Knight both say the entire category should be judged on the risk side of the equation first. "You can get into increasingly elegant versions of downside risk metrics," says Knight, but he thinks the important ones to look at are "those that focus on how often and how severely do you lose my money, and the third is comparing upside capture to downside capture."

He says that the standard deviation for returns has been a bit over 4 for the 500 fund and a little over 5 for the 700 fund. He compares that with an intermediate-term bond fund with a standard deviation of about 3 for the same period.

"The fact that we're taking 5% risk and making a 7% return, that's a pretty good combination," he says. "A 7% return is quite high in real terms in an environment of low inflation like we've had, and to get that without putting a lot of your capital at risk, those are the characteristics we're trying to deliver in these funds.

"I call it diversifying by philosophy," Knight says of absolute return. "Another way to add some diversification to your portfolio is to combine relative strategies with absolute return strategies."