(Forbes.com)(Forbes.com) Here's an appealing investment premise for scary times: mutual funds designed to offer positive returns regardless of how badly the stock market performs. That's the pitch of so-called "absolute return" funds, a breed of mutual fund that is receiving more than its share of marketing dollars as investment management firms seek to capitalize on investors' fears.

The concept behind absolute-return funds is that by owning a gaggle of investments that is "market neutral," they can eek out modest positive returns no matter how equities gyrate. By contrast, the typical mutual fund is defined as a "relative return" vehicle because it is graded on how well it performs relative to a benchmark that may itself be up or down over a given time period.

Normally, aiming merely to beat inflation wouldn't be considered much of a marketing pitch. But with investors spooked by the stock market's recent collapse, financial companies such as Putnam, Dreyfus and Goldman Sachs have launched absolute-return funds, and Vanguard is planning to offer one later this year.


"Financial advisers have clients who say 'I can't take it anymore. I want to know what my portfolio is going to do so I can plan.' That makes it easy for the adviser to say 'Putnam has these funds ...' " says Laura Lutton, an analyst at Morningstar.

The problem with absolute-return funds is that they've failed to meet the marketing hype. A recent study by Morningstar shows that of the eight on the market only one, RiverSource Absolute Ret Ccy & Inc., ended 2008 with a positive return. It was up 1.1 per cent. In the wake of a horrible year, that may sound pretty good — until you consider that if you'd stuck with a traditional hedge against stock volatility, like U.S. Treasurys, you would have done far better; the Vanguard Long-Term U.S. Treasury fund, for example, was up 22.5 per cent last year.

Investors should be rethinking the old conventional wisdom, but they are running in the wrong direction.

The tricks used by absolute-return fund managers to smooth the bumps aren't rocket science, but rather the sort of diversification that you can easily recreate yourself.

"It's extreme market conditions that drive the fund investor to want [absolute-return funds], but if they don't deliver when [stocks are going] down, that would shake anyone's confidence," says Lutton.

The tricks used by absolute-return fund managers to smooth the bumps aren't rocket science but rather the sort of diversification that you can easily recreate yourself. The funds tend to own grab bags of investments, ranging from small-cap stocks to government bonds to soybean futures. It's a game similar to that of absolute-return hedge funds, but without the extensive use of borrowed money to juice returns.

Putnam Investments is betting heavily on the appeal of absolute return funds. It launched four in January and bankrolled a sizable ad campaign. Putnam Absolute Return 100 is a prime example, stating that it seeks "a positive total return over a period of three years or more regardless of market conditions or general market direction. As a result, if this strategy is successful, investors can expect the fund to outperform the general securities markets during periods of flat or negative market performance."

Given how the market plunged early this year, you might think Putnam's timing was excellent. But consider this: Many investors who bought into its absolute-return funds near their launch are probably kicking themselves now. Since then, the S&P has gained 14 per cent, versus 2.2 per cent for the Putnam fund.

One objective that Putnam certainly achieved is to charge high fees for its hand-holding. Absolute Return 100 charges a 3.25 per cent upfront sales load plus 1.25 per cent in annual expenses. That's pretty expensive for a fund that tries to outdo U.S. Treasurys by all of 1 per cent a year.

Our advice: Forget absolute-return funds and instead allocate your assets the old-fashioned way. That means investing the portion of your assets you can afford to put at risk in a low-cost index fund or ETF. Put the rest in similar vehicles that own a mix of corporate and government bonds or have a bit of commodity exposure.

That will smooth the bumps just fine, but a far bigger portion of the returns will end up in your pocket and a far smaller one in the pocket of a money manager.