Wednesday, May 6, 2009

Mutual Funds: The Alternate Universe

Numerous investors are now seeking safety in their strategies, foregoing risk in favor of what is often referred to as value. Warren Buffet is often considered one of the great value investors, specifically looking for what is known as absolute value.

The strategy employed by fund managers in these types of funds does, in fact come with some risk, although the name suggests otherwise. Buying value is not as easy as it appears, requiring the fund manager to look at certain key aspects of the companies they are investing in before making a decision.

Absolute value funds look for stock prices that are selling for substantially less than what they perceive the company to be worth. This is no easy feat. It involves not just looking at the relation of the company's stock price relative to its peers on the S&P 500 but using a view of the assets involved, the business's balance sheet and the overall growth prospects. To do this might mean that a great deal of potential earnings in the share's price will be ignored in favor of the safety of basic material type investments. (A good example is the avoidance of tech stocks in the late nineties.)

Absolute Value fund managers pride themselves on ignoring market fads. Looking instead for out-of-favor p=companies, the manager of an absolute value fund will look to a long-term outlook as opposed to the short-term gains a market might offer.

Relative Value funds do something similar by looking at the dividend payouts for funds and using them to bolster the often slow rise of the company's share price. Dividends provide a big safety net for investors in these types of funds, even as a good many of the S&P500 companies cut them. Most fund managers will set a 2% dividend threshold when looking a dividend paying shares. (Rule of thumb for the average investor: a dividend in excess of 5% is often a warning sign of trouble ahead, even for value managers.)

Jean-Luc Nouzille, Portfolio Manager and Founder of Bristlecone Value
Partners, LLC offers this take on value investing: "The key emphasis for every absolute value investor is definitely the idea of investing when the
risk/reward situation is attractive. We believe that our first layer of risk management is the analytical work that we do on a company that we consider for
investment — looking at the balance sheet and the competitive situation and buying them at a big discount to what we think they are worth. Historically when you do that, the downside risk of those types of investments tends to be lower than the upside potential. So this emphasis on protecting your principal when you invest at a discount is a key to our process.

Be aware that this is not a stand alone strategy - a worry that many who look at the name, the idea of protecting principal, and the philosophy of this investment style - is not the only fund you should hold in your retirement portfolio. Newer funds claiming to be absolute value investments have seen huge inflows of mutual fund money. Some funds, like those recently launched at Putnam have offered targeted returns of up to seven percentage points over US Treasury bills.

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