Is The Tide Turning For Alternatives?

Charles Clough, chairman, CEO and portfolio manager at Boston-based Clough Capital Partners, believes that economic and market conditions are shifting to favor active and alternative asset managers.

“I think things are changing for alternatives,” says Clough, who will speak at Financial Advisor’s Inside Alternatives conference in Philadelphia in late October. “There are signals from the marketplace; there’s a process underway that should allow active management to do better.”

During the 10-year bull market, as many alternatives lagged traditional investments, some investors reduced alternative allocations or eschewed active management altogether in favor of capturing the growth of equity indexes. “There are no investors anymore,” laments Clough, who spent 13 years as Merrill Lynch’s chief investment strategist. “Something like 90% of NYSE trading is either based on indexing or algorithmic strategies. There aren’t any investors left. We’re a rare breed.”

Over the past decade, traditional bonds effectively diversified portfolios focused on capturing the strength of equity markets, but they may not be able to do so moving forward, says Rick Lake, chief investment strategist for F/m Acceleration and co-founder of Lake Partners, who will also address attendees at the Inside Alternatives conference. “In recent years, fixed income has helped to hedge equity risk,” Lake says. “With interest rates this low, it is going to be difficult for investors to rely on duration to be as effective a hedge.”

Since fixed-income returns are primarily a product of a security’s yield, a lower-for-longer interest rate environment typically leads to lower-for-longer bond returns, says Lake.

Furthermore, traditional assets have enjoyed an extended period of low volatility with very few interruptions, says Erol Alitovski, a manager research analyst on Morningstar’s multi-asset and alternative strategies team. “There hasn’t been a lot of downside to markets, and alternatives have underperformed, which makes a lot of investors question why they are in alternatives to begin with,” says Alitovski. “Another factor has to do with the volatility of markets and rates: When rates are low, and this is often not accounted for, a lot of volatility strategies don’t perform well.”

Clough says that alternatives and traditional investments, as well as actively and passively managed funds, undergo periods of outperformance and underperformance. He believes investors may be at the beginning of a cycle back toward management. “There tend to be periods that last about a decade where passive outperforms active, and then the baton changes hands and active outperforms passive,” says Clough.

Clough identifies periods in recent market history where passive indexes have clearly been the best-performing investments. For example, in the ’60s, the U.S. equity market was driven by the “Nifty Fifty,” 50 large-cap equities.

“What was happening in that era is that there were new monies coming into the stock market for the first time,” Clough says. “Corporations were investing their pension funds in equities for the first time since the 1930s, and almost all of the flows were controlled by six big New York banks.”