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.

Jason Cross, Ph.D.
Head of Equity Strategies
Whitebox Advisors 

The “Super-Stock” And The “Anti-Stock”—An Alternative View Of Long/Short Investing
Portfolio theory pioneer Harry Markowitz famously asked, “Why do investors own more than one stock?” His answer, “diversification,” is true, but incomplete. We believe investors own multiple stocks because all stocks have desirable and undesirable features. One stock might have good earnings growth but an unfortunate price-to-book ratio. Another might be attractive on price-to-book with strong growth, but less attractive on earnings quality.

Since there is no perfect stock, I think a better answer to Markowitz’s question might be “to create a portfolio approximating the one stock that would satisfy every investor.” Rather than assembling two lists of stocks—the beloved and the hated—the long/short manager could aim to build portfolios with the summed statistical characteristics of the “super-stock” every investor wants, and the “anti-stock” no investor wants.

For the long book, look for stocks with a broad base of moderately positive factors including value, growth, quality, and momentum, and few, if any, strongly negative factors. For the short book, do the opposite. Avoid stocks that score high (or low) because of a lopsided score on one or two factors. Such stocks tend to be overbought (or oversold) by “style” investors focused on that factor. The resulting long portfolio should look like a “super-stock,” and the short book like an “anti-stock.”

The super-stock/anti-stock approach is especially strong when volatility is high, both creating mispricings and pushing stocks quickly back toward fair value, potentially allowing the investor to take a profit and rotate capital into the next opportunity.

Over time, we believe the super-stock/anti-stock methodology can better express the true goal of long/short investing, which is not just to make selections from unsatisfactory choices but to bring to life that single stock all investors would be happy to hold.

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Frank Muller
Executive Vice President and
Head of Distribution, Behringer

Permanent Capital Funds: The Key To Unlocking The Illiquidity Premium?
Defined simply, the illiquidity premium is the compensation investors receive for holding an asset that is not readily convertible into cash. Sophisticated investors understand that the right balance of liquid and illiquid strategies may capture not only the benefit of diversification but also this coveted premium.

However, behavioral finance and real-world experience shows that investors often do the wrong thing at the wrong time—a conundrum that has plagued the hedge fund and real estate industries for decades as they attempt to invest in illiquid securities or investments. Investment managers are usually presented with redemptions at the worst possible times, and, although many investors understand that these actions can be counterproductive, they nevertheless demand them. Investment managers who attempt to mitigate irrational redemptions, either by discontinuing or closing their liquidity programs, risk frustrating their investors. Conversely, investment managers know that if they remain disciplined, patient and invested, they can not only weather market storms but may also be able to deploy capital to accretive advantage during times of market distress.
A listed permanent capital fund that can invest in illiquid investments is a wonderful tool; it can capture the illiquidity premium while providing investors with liquidity.

This closed-end vehicle allows managers to invest with a long-term perspective, knowing that the capital source is permanent. And while a permanent capital type fund may trade at a premium or discount to its net asset value (NAV), it is a fair price for investors to pay for liquidity. Moreover, the investment manager is not forced to liquidate illiquid assets at the worst possible times and may be able to deploy capital into the distress at attractive prices. This is where great managers can generate excess returns over their peers, who may be subject to the behavioral issues investors often demonstrate in periods of tumult.

The ability to potentially capture the illiquidity premium—through listed permanent capital vehicles that provide liquidity through an exchange and allow the underlying illiquid investments in the fund to stay intact—can bolster investor confidence in specialized asset classes and help advisors more efficiently allocate capital for their investors.

This article is intended for your private use and is for informational purposes only. Behringer undertakes no obligation to update or supplement this information at any time or in any way. This article does not account for the investment objectives or financial situation of any particular person or institution.

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Michael Mon
Portfolio Manager, Fixed Income, AB
AB Unconstrained Bond Fund – AGSIX

Unconstrained Bond Investing: Getting More Players In The Lineup
As markets focus on the Fed’s plans to raise short-term interest rates, awareness is growing that rates will eventually head back up. Many investors are becoming more aware of the risks posed by benchmark-based portfolios—and are moving to an unconstrained fixed-income approach. Why?

Toning Down Interest-Rate Risk: Benchmark-based investing worked well when rates were in a long-term decline, providing a major tailwind to bond returns. But the picture could change if rates start rising. In 2013, rates rose dramatically, and intermediate-term bond strategies suffered more than unconstrained approaches. Today, almost every bond index offers very low yields—and more interest rate exposure. That’s an unintended risk that unconstrained strategies have more room to manage.

Improving Flexibility: Benchmark-based investors can be limited in their ability to underweight certain investments, because the lowest possible exposure is zero. Unconstrained strategies with a strong negative view can take a short position, which would benefit if those bonds do poorly.
Shorting has risks if prices rise, of course, but the upward price movement of bonds has been somewhat bounded because of their structure.

Unlocking Value in a Low-Value World: Making a call on rates is only one aspect of bond investing—and it’s very hard to get right. What if you could express a strong view without adding interest-rate risk to a portfolio? When the price relationship between two bond segments becomes skewed, unconstrained portfolios seek to exploit these discrepancies by buying one and selling another at the same time—in what is called a long/short trade. This has the potential to add value. This idea can be extended to yield-curve opportunities, too.

With the long-running bull market for bonds likely over and indices showing some flaws, it may be time for benchmarked investing to make room for an unconstrained approach that can get more players in the lineup.

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Michael Winchell
Chief Investment Officer,
Larkin Point Investment Advisors LLC  

How Expensive Is Protection?

How often does a good advisor get a pat on the back?  After all, it’s difficult to tout the incremental gains of a long-term plan in an annual review, especially when some asset classes have delivered double-digit returns but a diversified portfolio has not.

In a world of negative deposit rates and negative bond yields, we believe advisors must keep trying to find new solutions for asset allocation.  When it comes to a search for downside protection, we think advisors should consider diversification based on equity options.   And even though some advisors have periodically rejected protective put options as too expensive, we think advisors should consider what’s happened to the cost of portfolio protection over the past 20 years.

Equity option pricing depends most on the expected volatilities of underlying stocks or indices. Because average implied volatility has remained relatively consistent over the past two decades, we believe options held for protection are relatively cheap when compared to traditional sources of protection.

What are the costs of some traditional diversifiers?  Consider sovereign debt, a traditional source of portfolio protection.  Will the prices of sovereign notes or bonds jump enough in an equity market selloff to rival the returns on long-dated put options?  While holding cash as an asset preserves value in a deflationary environment, how do you generate portfolio gains from cash in an equity market selloff?

Obviously, much of the potential gain on equity options depends on how far and how fast an equity market declines. Moreover, as there is a range of options-based solutions, there is a range of potential return profiles that require evaluation. Some funds buy short-term put options for protection.  Other funds sell call options for added income. Some funds do both. At Larkin Point, we tend to own long-term put options striving for long-term risk mitigation, and sell both short-term puts and calls in an attempt to generate income.  If you wish to discuss the pros and cons of different options-based solutions, give us a call.

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Michael Gregory
Global Head and CIO,
Highland Alternative Investors,
Highland Capital Management 

Finding Low Correlation To Diversify A Portfolio
To build the appropriate portfolio for a client, it is important to balance risk and return based on a client’s goals and needs. Of course, risk in a portfolio will be determined not just by how volatile the holdings are but also how correlated they are. Thus, correlation among holdings is a critical factor in portfolio construction, and yet it is often overlooked.

Many are surprised to learn health care is one of the least correlated sectors. As one of the largest drivers of GDP growth in the US, and a sector that is undergoing its greatest structural changes in 50 years,1 Health care has historically had a low correlation to other sectors and can be a valuable component for many portfolios. If we examine the correlation numbers from Bloomberg for all major S&P 500 sectors compared to the S&P 500 index (major sectors are those representing more than 10% of the S&P), the health-care sector has the lowest correlation over the previous six months, one-year, and five-year periods (for the six-month period, the S&P Healthcare Index is .7, versus most other sectors between .93 and .97).

 The health-care sector also has the lowest intrasector correlation. In other words, stocks within the health-care sector are significantly less correlated with stocks within the health-care sector when compared with the correlations of stock within other sectors.

So what does this mean in terms of investing in the health-care sector? The low correlation of stocks within this sector at a time of continued structural change creates an environment where there are clear winners and losers. A portfolio manager’s expertise is a critical component in creating alpha, but investing in the right sector can be equally as important. We believe there is no better way to take advantage of this opportunity than through a long/short strategy, and Highland’s L/S Healthcare Fund is uniquely positioned to do just that.

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1Source: National Coalition on Health Care as of June 2011

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David Saunders
Co-founding managing director of K2 Advisors
Co-lead portfolio manager for Franklin K2 Alternative Strategies Fund

Liquid Alternatives: Helping Clients Achieve Desired Outcomes
As a firm we recognize that our clients today seek outcomes from portfolios, whether it is to generate a near-term income stream, preserve capital, or grow assets within a certain risk profile. Actively managed alternative strategies, such as those offered through liquid alternative mutual funds, are integral components of outcome-oriented portfolios.

 A craftsman is only as good as the tools available in his tool kit, and we believe the same principle applies to active portfolio management and achieving targeted investment outcomes. Liquid alternatives represent an important tool aimed at meeting underlying client objectives. That is to say they are un-constrained; they do not need to mirror a benchmark.

Firms positioned as leaders in the area of liquid alternatives asset management and outcome-oriented investing should do well in the years and decades to come, given market trends. According to an August 2014 study from McKinsey & Company, liquid alternative mutual funds have grown tenfold since 2005, with a dramatic spike following the 2008 crisis. In a way, we have seen the retailization of alternatives, as more institutional quality hedge fund managers are delivering their alternatives investment expertise to a broader market via fully transparent and daily liquid multi-strategy, multi-manager mutual funds.  

The bottom line is that we believe there is a better way to build portfolios to achieve outcomes, and this better way incorporates the use of liquid alternatives. Better outcomes, however, are not always about achieving higher returns—it’s about achieving the right returns in the most efficient manner. Liquid alternatives give investors the opportunity to improve risk-adjusted returns, increase diversification, and better insulate portfolios from market volatility. Achieving goals and overcoming hurdles without subjecting investors to unnecessary risks is what they are about. We believe that risk does not have to be commensurate with expected reward. Clients should expect more from investments, and by building a portfolio including actively managed alternative strategies, they have the potential to gain a larger share of the upside than they give up on the downside.

Investors should carefully consider a fund’s investment goals, risks, charges and expenses before investing. To obtain a summary prospectus and/or prospectus, which contains this and other information, please call Franklin Templeton Sales and Marketing Services at (800) 223-2141 or visit Your clients or investors should carefully read the prospectus before they invest or send money.

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Sudhir Krishnamurthi
Senior Managing Director,
The Rock Creek Group, LP
Senior Portfolio Manager of Wells Fargo Advantage Alternative Strategies Fund


Multi-Alternative Strategy Can Bring A New Dimension To Clients
Many advisors are considering alternatives as a potential way to improve their clients’ ability to reach investment goals in today’s environment. They may benefit from multi-alternative strategies run by experienced, institutional-quality managers such as The Rock Creek Group, LP, a majority owned subsidiary of Wells Fargo.

Advisors might benefit from multi-alternative strategies for several reasons:

Effective strategy selection and manager due diligence require insiders. These tasks require deep experience and numerous industry relationships—especially because information on hedge fund managers can be obtained only through a direct dialogue with managers.

Diversifying effectively with multiple strategies requires both quantitative and qualitative analysis. The Rock Creek process compares our quantitative and qualitative assessments, investigates any discrepancies between them, and refines our understanding of each manager’s role in a portfolio.

Data must be transformed into usable information. As part of our investment process, our firm uses technological tools that present almost incomprehensibly large volumes of data in ways that can inform portfolio management decisions. For example, the Rock Creek Visualization Tool presents manager performance in five dimensions simultaneously. Our portfolio managers can choose from among a wide variety of dimensions; in a representative scenario, they might view the characteristics of the portfolio or manager in five dimensions:

• Return
• Risk, as measured by annualized three-year volatility
• Extreme shortfall risk
• Time
• Sensitivity to the commodity super-cycle

Building an alternatives portfolio is only the beginning. A portfolio must be monitored and maintained over time to account for changes in the economy and markets and shifts in the alternatives marketplace. Our investment, risk, and operations teams engage with managers regularly to update the firm’s intelligence on each manager’s key characteristics.

For more information and to request a copy of our paper, “Investing with 5-D vision in liquid alternatives,” please call 800-233-9350 or visit

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Jack Rivkin
Altegris Advisors

Long/Short Fixed Income—An Important Strategy To Consider Under The Liquid Alternatives Umbrella
In contrast to the last five years when quantitative easing pushed considerations of risk and attempts at alpha generation to the sidelines, we believe we have entered an environment where active management, in particular long/short active management, will provide a return profile across both equity and fixed income allocations exceeding straight beta plays.  Our biggest concerns are in fixed income; historically, one looked to allocations there as reducing risk in a portfolio while, on balance, providing almost equity-like returns. The long period of declining rates since 1981 has produced a set of historical statistics that may not accurately reflect the risk and return profile we may see on the other side of this monetary experiment.

With rates sitting near historic lows, the long-only outlook for fixed income is more volatile and, in our view, unlikely to produce upside returns or provide the type of insulation from a declining stock market it has previously. Rates could fall further, but this is unlikely in a growing economy.

Regardless of what the future may hold, long/short fixed income managers have the ability to take advantage of various interest rate and credit environments by investing across an array of fixed income sectors in investments of varying credit quality and maturity. The historical evidence does show that long/short fixed income managers have outperformed the Barclays Aggregate Bond Index in the periods of rising rates over the last 25 years. It is not the only reason to consider this liquid alternative strategy. Long/short fixed income managers who 1) understand the credit cycle, 2) have managed through periods of crisis, 3) possess the ability to generate yield at lower risk with less sensitivity to interest rates and 4) can take advantage of relative credit disparities and/or changes in the yield curve, potentially have an even greater opportunity to outperform. The relatively liquid nature of many fixed income instruments, coupled with the current opportunity set, make long/short fixed income another important strategy to consider under the liquid alternatives umbrella, as the U.S. moves back toward “normality” from the current fed funds level.  

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