The past week saw fund companies wringing their collective hands over whether or not investors understood the term "absolute return" and whether its use might lead to mis-selling.
While they're at it, the fund houses may want to reconsider how they use the term "alpha", also oft found in fund names.
The problem with both terms isn't just that they tell you precious little about what the fund does, it's that they only give one side of the story--the positive side that makes it easier to sell funds.
Absolute return refers to nothing more than a goal.
It sounds very good; the implication is that other funds may lose you money, but we, the absolute-return fund, will not.
It comes very close to naming your fund "loss-proof" or some such.
In reality, what matters is the strategy used to run the portfolio and how that strategy might fare in diffent market environments.
But if you called a fund the XYZ Long-Short UK Equity Fund or the XYZ Debt Arbitrage Fund, it wouldn't convey such a clean, positive connotation.
If a manager muffs his short sales, losses can indeed be significant, and worse, the upside may be very limited at market turns for a strategy that decreases its net exposure in down spells.
"Alpha" suffers from the same issue. The term itself is an innocuous staple of modern portfolio theory, and refers to the fund's ability to outperform a benchmark.
It's curious the term has been allowed by the regulators to appear in fund names. I expect they wouldn't be quite so willing to accept a name such as XYZ Outperformance Fund, but alpha appears to pass muster.
The funds that use the appellation are typically distinguished by the degree of active positions present in their portfolios. Unfortunately, the suggestion that this will generate "alpha"--at least positive alpha--is not warranted.
If a manager is good, and the fees low enough that all the alpha isn't eaten up by costs, it might have a positive alpha. But it could just as easily be negative, and highly negative if the fund is carrying a lot of active risk.
Alpha sounds great--it's a nice positive story for fund distibutors to tell. Selling the XYZ High Active Risk Fund wouldn't be quite as easy.
This article first appeared on FTAdviser.com.
