Investors are gravitating toward mutual funds with alternative-oriented strategies. If only the performance of these funds justified the love.
Seventy-eight such funds were introduced in 2011, according to Morningstar Inc., bringing the year-end total to 338. And assets in these types of funds rose about 20% last year, to $122 billion.
Unfortunately, all seven alternative fund categories tracked by Morningstar finished 2011 in the red. While some individual funds finished in the black, the overwhelming majority obviously didn't.
Market neutral funds were the best-performing category, with an average loss of 0.30%. Market neutral followers can employ a range of strategies to profit simultaneously from both rising and falling market prices.
The worst-performing category comprised bear market funds, which carried an average loss of 10.85%. Morningstar alternative investment analyst Nadia Papagiannis says that bear market strategists did well during the big market drop that lasted from late April through early October, but suffered when the markets soared during both the first four and last three months of the year.
Among the other fund categories: managed futures sank 6.92%; currencies lost 3.33%; long/short equity dropped 2.81%; multialternative fell 2.79%; and nontraditional bonds slipped 1.29%.
Alternative investments are pitched as a way to provide non-correlation--or certainly low correlation--to traditional equity and fixed income assets, with the aim being to shield investors from massive market drawdowns. But they also have to be able to generate positive returns, too.
"The idea of non-correlation is why investors think they want alternative investments in their portfolio," says Greg Levinson, portfolio manager of the Schooner Fund, which fits into Morningstar's long/short equity category. "The fact that returns are non-correlated is a characteristic of that return, but it shouldn't be the end goal."
The Schooner Fund gained 2.64% last year, and is up roughly 5.5% so far in 2012. The fund employs volatility-based trading strategies to smooth out returns and, hopefully, generate positive returns.
"What investors really care about is conditional correlation," Levinson says. "They want to participate when markets go up; they like that correlation. But they don't want to be correlated when markets go down."