Absolute-return funds may only comprise $140 billion, a scant 1.2% of the $11.26 trillion in mutual funds, but that will grow to 10% to 15% over the next decade, predicts Putnam Investments President and Chief Executive Officer Robert Reynolds.

Driving this demand will be a listless equity market for the foreseeable future and investors who now prefer positive returns to funds that simply aim to beat a benchmark and adhere to static asset allocation, styles and geographic diversification, said Reynolds and other speakers at Putnam's first Absolute Return Symposium in New York.

Gabriel Burstein, global head of portfolio solutions and investment research at Lipper Thomson Reuters, said that in the 1970s, when the Dow Jones Industrial Average moved sideways but only slightly upward, the timing was perfect for Vanguard's introduction of passive index funds. "Since 2000, the market has switched from its old dogma and is totally unpredictable. As a result, we have seen the emergence of absolute-return and alternative mutual funds that work irrespective of market direction."

"Set it and forget it is done," agreed Cynthia F. Steer, chief research strategist at Rogerscasey. "Economics and mathematics have changed. Style boxes are not where the world is going to be. I need a wider toolkit with more strategies."

"The investment continuum has broadened to include skill-based, flexible strategies," said Jeffrey Knight, managing director and head of global asset allocation at Putnam.

"Buy and hold is over," Burstein added. "This market will not deliver any sustained trend. You cannot make money in a market that is directionless." That's why retail investors now need the "diversification of strategy" and "progressive risk management" that absolute return funds offer, he said.

"We are facing a very strange combination of high volatility in the equities markets and zero yield on fixed income, creating a truly profound need for an alternative," Reynolds said. "Absolute return is a new solution that has really touched a nerve by offering less volatile, more predictable returns. We as professionals need to stretch the bonds of diversification to think outside the style box."

By comparison, relative return funds aim at beating a benchmark, even if it declines, whereas absolute-return funds must deliver real returns regardless of the market direction, Reynolds explained. "Absolute return managers prioritize limiting losses and risk and are paid for delivering positive returns. Relative managers are paid if they beat the market," even if their clients lose money.

Indeed, the suite of four Putnam Absolute Return funds that the firm unveiled on Dec. 23, 2008 have outpaced their goals. Through Sept. 30, the Putnam Absolute Return 100 Fund, which aims to beat the U.S. Treasury bill net of expenses by 100 basis points, has delivered a 2.4% annualized return. The Putnam Absolute Return 300 Fund has delivered 5.2%, the Putnam Absolute Return 500 Fund is up 5.7% and the Putnam Absolute Return 700 Fund is up 8.6%.

As an asset class, absolute return funds declined 10% in 2008, whereas the broader market dropped 37%, Reynolds noted.

Putnam's funds have achieved their performance by investing in short-term bonds, equities and hedging strategies. Specifically, the 100 and 300 series invest in: cash equivalents, asset-backed securities, emerging market debt, commercial mortgage-backed securities, foreign currencies, high-yield corporates, international bonds, Treasury Inflation-Protected Securities, investment-grade corporates and U.S. government bonds. In addition to these assets, the 500 and 700 series also invest in: commodities, emerging market stocks, international stocks, U.S. stocks and real estate investment trusts.

And in this timeframe, the Putnam funds have amassed nearly $3 billion in assets, sold through 9,000 financial advisers.

"Absolute-return investing has been a feature of institutional and high-net-worth investors for decades," Reynolds said. "The only thing new is its emergence among mainstream America." Given the volatility investors continue to face and the catastrophic losses they suffered in 2008, "absolute return funds should play a role in every investor's portfolio and in every adviser's toolkit. The question is not if but how much-5%, 10% or 50%? Can they be used as a qualified option in workplace savings plans? Should they be a building block for 529 college savings plans? Are they a viable alternative to passive investing? Can they comprise lifetime income planning? We argue that they are all of the above."

Reynolds continued: "I expect we will see many more applications, including solutions we haven't even seen yet. We are only beginning to see a sense of their emergence as a major category, like lifecycle funds. The takeoff will be dramatic, like light speed. We aren't there yet. But that is the rate at which they will grow."

However, for absolute return funds to become mainstream will take considerable education among both investors and financial advisers. A survey of 256 advisers by Brightwork Partners in early November found that retail advisers understand and embrace absolute-return strategies as a tool to mitigate market volatility. However, absolute-return strategies are still a novelty for most advisers, who are not accustomed to talking about "return philosophies" of absolute versus relative. And to date, many advisers are focused on the funds' high expense ratios, short retail track records and the difficulty of explaining them to clients.

Thus, for the time being, said Merl W. Baker, principal with Brightwork Partners, absolute-return strategies may be attractive to advisers looking to move clients out of fixed income or cash. Over the next 12 months, 56% of advisers intend to increase their clients' allocations to equities, and 33% will move more money into alternative investments such as absolute-return funds.

"We have transitioned very much to outcomes. Advisers' practice objectives show a very different view than a few years ago," Baker said. The survey showed that 88% want to deliver secure and adequate retirement income for clients, 86% want to help retired clients pace portfolio withdrawals appropriately, 74% want to help clients keep up with inflation, and 66% want to secure adequate returns in view of market volatility.

But currently, only 10% of advisers view absolute-return funds as a very effective way of reducing volatility. Sixty-three percent say that can be accomplished by diversifying across a greater number of asset classes. "That shows some serious baggage [against absolute return]. We have a long way to go," Baker said.

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