In the wake of the 2008 financial crisis, mutual fund sponsors launched a broad array of liquid alternative funds. Think of them as proxies for hedge funds, many of which are designed to deliver non-correlated market returns. The term “liquid” reflects the ability to buy or sell the mutual funds on a daily basis, a feature that traditional hedge funds lack.
Following in their wake were a smaller group of alts ETFs that launched over the past decade. Not only are these funds built to provide downside protection in tough markets, but they are often structured to provide positive absolute returns in most market conditions.
Yet recent history has not been kind to alts funds. Their paltry returns made them the black sheep of the investment landscape during the impressive decade-long bull market in equities. But that bull has just about expired, as the fourth quarter was one of the most challenging periods in many years and 2019 promises similar levels of volatility and uncertainty.
Is it time to reconsider alt ETFs? If the recent market turmoil is any indication, these funds retained much of their value during December's ugly downturn, and some of them produced gains.
Take the IQ Hedge Multi-Strategy Tracker ETF (QAI), which has an asset base exceeding $1 billion and is an alts ETF pioneer. While the S&P 500 Index fell around nine percent in December, the QAI fund slipped less than two percent, according to XTF.com. And the fund’s fourth-quarter and full-year drawdowns were also far more muted than the S&P 500.
Those results are in keeping with long-term studies about such alternative investments. At the end of 2014, Hedge Fund Research Inc. (HFRI) performed a landmark study that looked at two decades of market performance. In that time, stocks rose an average 0.79 percent per month, compared to a 0.70 percent monthly gain for alternative investments.
Considering how massively stocks outperformed alts in the final five years of that analysis, it becomes apparent that alternative investments fared quite well in the prior 15 years.
Just as important, alternatives have delivered respectable long-term gains with much lower volatility. Over the 83 down months in that 20-year period, stocks fell an average of 3.87 percent. Alts fell by just 1.07 percent, according to HFRI. And standard deviation of returns for alts are around one-third the amount of volatility seen by equities.
The cost of such hedging doesn’t come cheap. The QAI fund, for example, has total annual operating expenses of 0.79 percent (though that’s still lower than the vast majority of alts-focused mutual funds, and is way less than expensive hedge funds).
With a 0.65 percent expense ratio and modestly positive total returns in 2018, the WisdomTree Managed Futures Strategy ETF (WTMF) may be a cost-effective vehicle for capital retention. With $260 million in assets, this is the largest of the managed futures ETFs. And though the JPMorgan Managed Futures Strategy ETF (JPMF) has a smaller $50 million asset base, it also offers a slightly lower 0.59 percent expense ratio. Both funds eked out a positive total return in December, according to XTF.