Liquid alternative investments are increasingly becoming the answer for investors who want to achieve greater diversification, reduce volatility, preserve capital and generate income. Although not meant to replace core holdings, liquid alternatives can provide smaller investors the chance to benefit from investment approaches that were previously only available to institutions. The choices among liquid alternatives are many, however. Advisors can add value for clients by understanding various strategies and determining when they are appropriate for client portfolios. The following commentaries from leading liquid alternative fund managers provide insight on many popular strategies.


Scott Crowe,
Global Portfolio Manager,
Resource Real Estate 



Interval Funds Could Unlock Alternative Investments To A Wider Investor Base
In the wake of the global financial crisis, investors realized that simply having a range of mutual funds with access to different “sectors” may not be enough to create appropriate diversification.  Additionally, plummeting bond yields have left investors without the ability to generate income.  As a result, investors are becoming increasingly interested in alternative investments.  

Alternative investments—which can decrease a portfolio’s volatility and correlation with equity markets while offering the potential for increased return — were traditionally available exclusively to large institutional investors. But now, the “mass affluent” are demanding the same access to more sophisticated alternatives.

The interval fund is an example of the next evolution in alternative investments. An interval fund is a new type of mutual fund that offers daily investment opportunities and redemptions at specific intervals (usually quarterly). Interval funds can provide individual investors with access to alternative investments while also providing fee transparency and a liquidity feature. Additionally, interval funds can lower the expense of investing in alternative assets by aggregating capital, thus decreasing costs as a percentage of assets. Since interval funds are a type of mutual fund, they can be held in both fee-based and commission-based accounts.

Interval funds help meet the demand for investments that provide yield while also providing diversification and low correlation to the equity markets. An interval fund provides access to a portfolio of alternative investment securities and can replicate the benefits of an institutional approach that more individuals desire. In addition, the flexibility of the mutual fund structure can help advisors adapt in an evolving regulatory landscape.  As with other investment products, there are important aspects to consider when assessing the merits of an interval fund. These include the investment strategy, management track record, and liquidity structure.

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Mino Capossela,
Head of Liquid Alternatives,
Credit Suisse Asset Management


Building Better Portfolios With ALTS™
When constructing portfolios, investors generally seek an optimal combination of income generation, growth and capital preservation. Historically, investors used stocks, bonds and commodities to accomplish these objectives. While exposure to these traditional asset classes remains a core portfolio component, it is prudent for investors to consider expanding their portfolio construction toolkit to better accomplish their investment goals.

One area receiving increased investor interest is alternative risk premia, which are returns earned for taking risks in alternative investment strategies. Like their traditional counterparts, these economically intuitive strategies can also be categorized according to their roles in a portfolio.  For example:

• Income: Carry strategies seek to generate income by going long high-yielding assets and shorting low-yielding assets

• Growth: Equity value strategies seek to generate growth by monetizing the tendencies of certain assets to revert to their intrinsic and fundamental values

• Capital preservation: Trend/Momentum strategies, such as managed futures, can act as a portfolio diversifier by potentially benefiting from both positive and negative price trends

The potential benefits of allocating to alternative risk premia are twofold. In addition to providing investors with non-traditional sources of return, these trading strategies may offer diversification benefits when incorporated into a portfolio of traditional assets. Alternative risk premia are often lowly correlated to traditional assets (and to each other), which can lead to a noticeably improved risk/reward profile.

Investors can now access many alternative risk premia in transparent and liquid investment structures.  However, a high level of investment expertise is needed to understand how individual alternative risk premia tend to perform in different market environments, as well as how they interact with each other when combined within a portfolio.

For more information and to request a copy of our paper, “Alternative Liquid Trading Strategies: Building Better Portfolios,” please email [email protected].

These materials do not constitute an offer to sell or a solicitation of an offer to buy securities.

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Sean Clark, CFA
Chief Investment Officer,
Clark Capital Management Group 



With Great Power Comes Great Responsibility: A Client Centered Approach To Liquid Alternatives
The days of buying gold and real estate and calling it a day are long gone. The proliferation of liquid alternatives, largely fueled by the mutual fund and ETF industry, has democratized investing in alternative asset classes.

In our view, access to liquid vehicles provides advisors and investors with the tools needed to build better portfolios.  But as Voltaire put it, “With great power comes great responsibility.” I would argue that nowhere across the current investment landscape is this statement more relevant than in the liquid alternative space.

Ask:  “Does It Make Sense for My Client?”

Because it’s such a broad and complex investment category, it is important to identify the client’s personal objectives and the outcomes they are trying to achieve.

For many investors who have enjoyed the run higher in global stocks over the past five years, it may make sense to reduce risk and lower overall portfolio volatility by adding alternatives, especially given the current equity valuations, high cross-asset class correlations and concerns over rising interest rates.

Where Liquid Alternatives May Contribute
1. They may help deliver the income and stability clients have come to expect from traditional fixed income vehicles but strip out less savory elements such as duration and interest risk.

2. They may reduce overall volatility in a client’s portfolio by introducing non-correlated asset classes, such as hedging
vehicles, commodities, currencies, hard assets and futures within a liquid structure.

3. By tactically managing credit exposure, clients’ exposure to income generating vehicles may be retained, with the added
benefit of risk management and the ability to shift toward safety.

In our opinion, a practical way to allocate to liquid alternatives is through a manager with a seasoned track record in the space.

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Michael Winchell,
Chief Investment Officer and Managing Member,
Larkin Point Investment Advisors LLC


What Makes An Alternative Investment The Right Alternative? Seeking Low Correlation Might Miss Low-Volatility Solutions
If you have been thinking about adding alternative investments to clients’ portfolios, it’s important to step back and analyze the various types of investments available to you—which, despite being lumped together in the same category, are stunningly varied.

In general, alternative investments represent either 1) long positions in non-traditional assets such as timber,currencies, metals, farmland, etc.; or 2) investments in alternative strategies in which the returns of traditional and/or non-traditional asset classes are re-shaped by combining long and short positions, hedging with options, utilizing leverage, and so forth.  

Many advisors seek alternative investments solely on the basis of low correlation to equities (although a few advisers have indicated to us they are worried about the correlation to bonds). That makes sense when considering adding a long position to a portfolio holding equities.

However, if the advisor is willing to utilize an alternative strategy, a wider array of return and volatility profiles is available than can be found among the collection of non-traditional assets. Today, numerous strategies are accessible to investors in liquid form as a mutual fund or ETF, including long-short equity, equity market neutral, unconstrained bond, credit arbitrage, global macro, managed futures, dedicated short-bias, volatility, absolute return, and so on. In addition, there are also multi-strategy, multi-manager funds and single-strategy, multi-manager funds.

In order to execute an alternative strategy, any asset, even a collection of non-traditional assets, can be combined with other assets or derivatives, long or short, in a single fund. Return distributions are then targeted based upon liquidity, leverage, market-timing decisions, and perceived relative value. Short positions can be established alongside long positions. Options can be used for protection, income, or both.

The desired result of such hedging strategies is to reduce overall portfolio volatility relative to that of the underlying asset. If successful, an alternative strategy will reduce the fund’s volatility relative to the underlying asset without reducing returns by the same percentage. The alternative strategy may achieve the same goal (reducing portfolio volatility) as combining non-correlated assets together, but the correlation to the underlying asset might remain highly positive.

For an extreme example, consider a strategy holding a hypothetical ‘perfect put’ option on the S&P 500.  A ‘perfect put’ option would erase all losses incurred on an investment in the S&P 500 any day the market declined in price. On the other hand, given any day the S&P 500 increased in price, a perfect put would experience no loss.  With such perfect hedging performance, a ‘perfect put’ would show a negative correlation to the S&P 500 of about -0.80.

Obviously, no such hedging tool exists in real life.

But as the put serves as a hedge within the fund, a wealth manager would not be able to measure that negative correlation directly.  Instead, measuring the fund’s correlation to the S&P 500, the advisor would still find a high, positive correlation of about +0.85.  This is because the fund, holding both the ‘perfect put’ and the stocks making up the S&P 500, would still share all of the upside variance of the S&P 500!

Clearly, the hypothetical fund using this hedging strategy would be a superior replacement for an un-hedged investment in the S&P 500 (having captured all of the gains of the S&P 500 but none of the losses) and a likely core allocation.  If advisors seek only funds with low correlation, they may very well miss a fund with great returns and low volatility.

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Alexander D. Healy, Ph.D.,
Director of Strategic Research and Portfolio Manager,
AlphaSimplex Group, LLC 



Market Volatility Has Implications For Investors
Market volatility, as measured by the VIX, was relatively low for the first three quarters of 2014. Yet, as we saw in October, things can change quickly. The volatility of volatility, or how rapidly volatility changes over time, has increased in recent years and this has implications for investors.

First, a broader view of risk is essential. As of September 30, AlphaSimplex Group’s measure of U.S. market risk, the Downside Risk Index (DRI),* was below average at 41 (out of 100). However, when we analyzed global markets, the story was different: European market risk appeared above average at 81. Given that global markets tend to be highly correlated, this large dispersion suggested one of two things was likely: either risk in the U.S. would rise, or risk outside of the U.S. would fall. Either way, investors need a broader view of risk.

Second, investors need to prepare their portfolios for sudden changes in volatility by allocating to truly diversifying strategies. Our research into market behavior suggests investors make poor decisions in times of stress because they are influenced by emotions. As a result, investors are looking for ways to construct more durable investment portfolios that take into account the risk of rapidly changing market conditions. For example, some are adding liquid alternative strategies with low correlation to stocks and bonds, such as trend-following strategies like managed futures.

Third, investors should consider products that systematically factor in changes in risk and volatility—so that they don’t have to. We believe markets are adaptive and volatility is not a constant. While AlphaSimplex does not attempt to predict future volatility shifts or macro events, we extensively research and analyze market behavior and risk. Based on these insights, we build products that systematically adjust to changing volatility and risk, removing emotion from the process.

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Scott Schweighauser,
Partner, President and Portfolio Manager,
Aurora Investment Management LLC 



Favorable Opportunity Set For Hedge Funds
In the face of anemic bond returns, stock market uncertainty, and the prospect of higher interest rates, generating an attractive long-term portfolio rate of return has once again become challenging. Dynamic and diversifying hedge fund strategies—which historically have exhibited low correlation to traditional markets and provided downside protection during declining markets—can offer investors more ways to “win” through the ability to go long and short, while mitigating market volatility and portfolio sensitivity to broad market risk factors.

Market conditions for hedge fund strategies are favorable today. The retreat of macroeconomic factors as drivers of markets and security values has fostered an investment environment that can reward successful security selection, both long and short. Declining levels of intra-stock correlation and increased dispersion within certain sectors has led to increased alpha opportunities for equity-based, fundamentally-oriented strategies such as long/short equities.

Rising rate environments can also create opportunities for hedge funds. A hedge fund manager can use dynamic trading strategies to capitalize on market dislocations while actively managing exposure to interest rate-sensitive segments of the market. Rising rates lead to higher borrowing costs, providing an additional tailwind for security selection strategies. Today’s active corporate event environment also favors activist and event-driven managers.

Ensuring exposure to the most talented and competent managers practicing these strategies requires significant resources, infrastructure and expertise. By investing through an actively monitored and dynamically allocated portfolio of hedge funds, an investor can access multiple high-quality managers in diverse strategies. A hedge fund allocator can also tactically adjust strategy allocations and exposures to underlying hedge fund managers to emphasize those best suited for a particular market environment and take advantage of investment opportunities.

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Michael T. Buckius, CFA,
CIO, Senior Vice President and Portfolio Manager,
Gateway Investment Advisers, LLC



Higher SKEW May Indicate Investor Preference For Index Options
The options market is signaling nervousness. According to the Chicago Board of Exchange SKEW Index (“the SKEW”), recent expectations of large losses in the equity market are about double the normal level. The CBOE SKEW Index uses S&P 500® Index options pricing to determine how much investors are willing to pay for protection from a negative outlier return. A higher SKEW reading indicates the option market has priced in a higher probability of a negative “tail event,” or a return that would fall in the extreme left tail of a distribution of monthly returns for the S&P 500 Index. Current SKEW Index levels are high by historical comparisons and the indicator has been above average for over a year.

Is this market environment potentially one of the most risky in the last 25 years?  While the list making investors nervous is lengthy—including slowing economies in Europe and China, geopolitical tensions in the Ukraine and the Middle East, democracy protests in Hong Kong, the global spread of the Ebola virus, and changes to developed market monetary policies—the risks are hardly unprecedented in terms of the market’s tolerance.  

Rather than extreme nervousness, SKEW may indicate investor preference for index options as a source of downside protection over more traditional sources such as long positions in U.S. Treasuries and short positions in the equity market.  Investors may be hesitant to short equities because of the persistence of the market’s advance and remain wary of high-quality fixed-income instruments due to historically low interest rates.

Investors seeking downside protection may find low-volatility equity strategies appealing. These strategies can offer exposure to potential downside protection by using index put options, but may also help manage the cost of that protection through strategies that fund put option buying with call option selling. Such strategies may allow investors to participate in market advances while providing downside protection during short-term, severe market declines.

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Matthew J. Eagan, CFA,
Portfolio Manager,
Loomis, Sayles & Company, LP 



Seeking To Limit Volatility In A Challenging Global Bond Market
Currently we continue to temper our assessment of the rate environment. We believe the 10-year U.S. Treasury will reach 3.25% by the third quarter of 2015, but we do not believe rates will go much higher. Longer term, the picture for Fed interest rate policy has become more “hawkish.” Further, there is potential for increased rate volatility as the market digests the date and pace of future rate hikes.

We believe credit spreads are tight and expensive, and they may stay that way for a while given strong investor demand for new issues and general yield-seeking behavior. The global bond market remains challenging, as desynchronized recoveries among major economies may protract the global economic recovery and keep inflation low.

Within emerging markets, we believe overall fundamentals remain relatively sound. However, some countries, such as Brazil, may face slower growth, which, if prolonged, may reverse recent improvements. Better growth in the developed world should be a positive factor for emerging markets. Recent actions from the European Central Bank (ECB) on enhanced liquidity in the euro zone may provide support to the higher-yielding emerging markets.

We expect the strong U.S. dollar to continue given the U.S. economy’s relative health. We are moderately positive on the Norwegian krone due to its recent underperformance versus other developed market currencies. We have a less favorable view of the euro and yen, as the ECB and Bank of Japan maintain efforts to reflate their economies and ease monetary conditions.

We believe non-traditional absolute-return-oriented strategies may serve as an effective replacement for or complement to traditional core fixed-income strategies, introducing similar return and volatility targets while broadening the investable universe. These strategies allow managers the flexibility to opportunistically venture away from benchmarks and typically emphasize the risk side of the risk-return relationship, seeking to actively mitigate downside and limit volatility.  

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Steven Brod,
CEO,
Crystal Capital Partners



Stand Out With A Quality Alternative
With over 20 years of experience, Crystal Capital has witnessed firsthand the development of a $2.7 trillion industry that is growing and has increasingly become an important component of the institutional investors’ asset allocation. Institutional investors, such as pensions, endowments, foundations, and sovereign wealth funds, are generally afforded the advantage of size and unlimited resources, which offers access to top-tier managers and the ability to construct a portfolio that is uniquely tailored to their own goals and objectives. We are largely focused on democratizing the hedge fund investing landscape as our motivation today is to provide independent advisors and other financial intermediaries the ability to customize their own hedge fund program in a similar manner to the endowment model.

Since launching our Customized Hedge Fund Portfolio Solution in 2009, advisors were presented with the opportunity to stand out with a quality offering. With our service, they can construct a customized hedge fund portfolio for their qualified investors by accessing 75+ institutional-quality funds without the prohibitive minimum investments and operational complexities generally required. In 2014, with the goal of continuing to level the playing field, we launched our Customized Strategy Hedge Fund Portfolio Solution with the intention of bringing customized hedge fund investing to accredited investors.

Through our comprehensive service, advisors have the opportunity to grow their business and provide their clients with a customized solution that includes exposure to institutional-quality hedge funds that have historically been reserved for the most sophisticated investors.

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For more information visit www.crystalfunds.com.