Investors who bought into "absolute return" funds hoping to make money in relentlessly turbulent trading are instead finding their capital eroded in markets that are making a habit of sudden mass flight from risk.
High correlation among different asset classes and shrinking liquidity are making life difficult for the $180 billion-plus absolute return funds industry, which unlike hedge funds has limited means to ride out volatile markets.
With some governments mired in the eurozone's two-year-old sovereign debt crisis and some money market funds - also meant to be ultra-secure - under pressure from high exposure to the banking system, the choice of assets where investors can seek refuge is shrinking further.
Absolute return funds invest in a wide range of assets including equities and bonds and use derivatives like credit default swaps to dampen volatility and manage downside risks.
These funds have garnered interest after the introduction of a European regulation in 2001 that allowed a wider group of investors to gain access to hedge fund-like strategies. But they do have constraints on physical shorting of securities and command high performance fees, often stretching to double digits.
And their performance has been far from encouraging. According to Lipper data, absolute return funds denominated in the Swiss franc, euros and sterling lost on average 3.5 percent in the 10 months to end-October, compared with a return of 2.4 percent in the same period in 2010.
"Absolute return funds are there to dampen down downside risk but you can't get everything right. The risk of return-enhancing absolute return funds is that you may have illiquidity and deliberate, unforseen, voluntary or involuntary leverage in them," said Bill O'Neill, chief investment officer at Merrill Lynch Wealth Management.
"They may have more correlated assets and may prove more sensitive to markets than you think. They are for return enhancement, not pure capital preservation."
A loss of 3.5 percent underperforms a pure index tracker fund investing in benchmark indices - S&P 500 index lost just 0.75 percent in the same period, worrying for investors looking for an alternative in times of market turmoil.
In Europe, flows into absolute return funds fell to 5 billion euros ($6.7 billion) in the first 9 months of this year, just three percent of total assets. This is a sharp slowdown compared with inflows of 27 billion euros in the whole of 2010, or around 20 percent of total assets.
In contrast, global bond funds attracted 16.7 billion euros in the same period, about 10 percent of total assets. "If you are choosing absolute return funds you have to be careful. There's no free lunch," O'Neill said.
The worst performer among the funds is a euro-denominated mixed asset fund by Germany's HANSAINVEST which lost a whopping 45 percent in the 10 months to October.
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