Putnam's Absolute Return Funds: Same As It Ever Was
If you missed the recent launch of Putnam's new Absolute Return funds, you really have only yourself to blame. Their debut earlier this year was backed by a full court press push: full page color ads, press releases, interviews, and prime real estate on the Putnam website. The four funds -- dubbed the Absolute Return 100 Fund, 300 Fund, 500 Fund, and 700 Fund -- intend to provide something that should be an easy sell in today's markets: Consistent performance with low volatility. The funds aim to earn returns that outpace Treasury bills by one, three, five and seven percent respectively. Unfortunately, they seem more likely to follow in the footsteps of the vast majority of the mutual fund industry's other "innovations."
On the Putnam website, CEO Robert Reynolds says that the Absolute Return funds were created as a "bold response" to the "challenge of historically volatile financial markets," and that these funds are "absolutely for all kinds of investors." That's a nice thought, but what one person calls a "bold response" might also be considered, a bit more cynically, as an attempt to capitalize on the mood of the day.
The cynics have the benefit of history on their side. As you can see from the accompanying charts (click for full-sized versions), the mutual fund industry is forever fighting the last war. Whether technology funds in 2000 or emerging market and commodity funds in 2008, the industry has demonstrated a tremendous capacity for providing precisely the wrong type of investment at precisely the wrong time. The reason isn't difficult to understand: it's far easier to sell something when everyone's clamoring for it, which is usually just before hot sectors and styles flame out.
We have yet to see whether the new Putnam funds will fit this historical pattern, but there's no denying their goal fits the mood of the day. The question, of course, is how successful they'll be in achieving "absolute" returns with low volatility. In that regard, the odds are against them.
Consider the 500 and 700 funds, which are advertised as alternatives to balanced and stock funds, respectively. According to the prospectus, the fund managers will attempt to add value through the use of "overlay" strategies, which the prospectus defines as "active trading strategies designed to provide additional total return through the exploitation of market inefficiencies and other conditions."
Exploiting market inefficiencies. So much for concerns that they wouldn't have a plan. I can only imagine walking into David Swensen's office at Yale to pitch my asset-management strategy:
"David, I'll be adding total return by exploiting market inefficiencies.""Why didn't I think of that? Can you handle $1 billion?"
Of course, those active trading strategies will undoubtedly be accompanied by a fair amount of trading costs, which will increase the funds' already considerable expenses. The funds' A shares have expense ratios that range from 1.25 percent for the 100 Fund to 1.65 percent for the 700 Fund (net of fee waivers), and are accompanied by front-end sales loads of 3.25 percent (for the 100 and 300 funds) or 5.75 percent (for the 500 and 700 funds).Thus an investor who holds the 500 Fund for five years might be on the hook for total annual expenses of 3.2 percent (a 1.5 percent expense ratio, plus the annualized sales load of 1.2 percent, plus trading costs conservatively estimated at 0.5 percent). If the Treasury bill return over that period is 2 percent annually, the fund would have to return 10.2 percent annually to meet its goal.
Sounds like a stretch. If only we had some sort of a track record to determine if that's a reasonable expectation.
As luck would have it, we do. Back on page 57, in the appendix of the prospectus, we're informed that Putnam manages other accounts "that have investment objectives and policies that are substantially similar to those of the Absolute Return 500 Fund." So, how have they fared? Not so hot, actually.
In the year ended September 30, 2008, the "other accounts" lost 7.8 percent, while the Treasury Bill Index gained three percent. From their July 1, 2006 inception, the "other accounts" have earned 3.8 percent, compared to the Treasury Index's gain of 4.2 percent -- falling short of their target by 5.4 percent. It is, admittedly, a short time frame, but if you're setting "bold" targets, you should expect to have your record scrutinized.
To help alleviate concerns about performance, Reynolds points out that they have a "fee structure that aligns the interests of manager and investor.... If the funds don't achieve the target returns, [Putnam] will be paid less." Now we're talking. How much less, exactly?
Well, you might call it "a bit" less. The maximum adjustment on the 100 Fund is -- hold your breath -- 0.04 percent. On the 300 Fund, it's 0.12 percent; 0.2 percent on the 500 Fund; and 0.28 percent on the 700 Fund. So yes, they do have a bit of skin in the game, but barely enough to require a Band-Aid should they lose it.
In sum, Putman is offering a new suite of funds with high expenses, sales loads and a poor track record at the precise moment in time when they should have the broadest appeal. As my grandfather liked to say about deals like that, "Cover your wallet."