Global risk is another reason to consider liquid alts, she says. If China’s above-trend credit growth is followed by a slowdown in credit growth—which has typically occurred elsewhere—it could impact global GDP, global markets and other economies, she says. As for Europe, where Brexit and key elections signal rising fragmentation, “Our longer term view is it’s an unstable equilibrium,” she says.
Overall, “We think the traditional assets over the next five or 10 years won’t do as well,” says Borré, “and alternatives will be more valued in a portfolio because of the diversification they provide.”
Nicolas “Nico” Amato, head of alternative portfolio management for Wilshire Funds Management, which closely tracks liquid alts, also sees a strengthening case for these hedge-like funds.
For the first time in a long time, the markets are starting to see much more dispersion, he says. Not only has the correlation within sectors fallen, he explains, but it’s also very low between sectors. This makes it easier for active managers to show how they can add value. Already, “We’re starting to see more alpha through security selection,” he says. He also expects market volatility to rise as risk-free rates rise.
What’s Hot And What’s Not?
Manager selection is extremely important in liquid alts. An “average” return doesn’t reveal much about what’s happening in a category, says Icten of Morningstar, because its funds can have vastly different objectives and performance.
Still, he thinks long-short equity and market neutral are probably better positioned going forward than other strategies because they look more at stock-specific niche opportunities. “These opportunities are generally there regardless of market environment,” he says.
Conservative investors seeking bond-like risk return profiles may want to consider merger arbitrage strategies, he says. Managed futures, which look for big trends to emerge, remain very challenged by range-bound markets, he adds. For example, the U.S. dollar, crude oil and 10-year rates can’t find their direction and keep reversing.
Icten likes the Boston Partners Global Long/Short Fund (BGLSX). Its track record isn’t great because international stocks haven’t done particularly well in the past three to five years, he says, but diversification into international markets may be likelier now that many investors think U.S. stocks are overvalued. Boston Partners has a solid investment process and team, he adds.
Another fund he likes is the JPMorgan Hedged Equity Fund (JHEQX), which he says reduces equity risk by investing in equities with an option collar strategy. The fund looks like a 60/40 portfolio, he says, but there’s no duration risk because it doesn’t invest in bonds.
Borré encourages advisors to think about “the roles and the goals” of liquid alts. In other words, she asks, what role is a fund expected to play and is that goal realistic given the characteristics of that fund?
Her multi-strategy Oppenheimer Fundamental Alternatives Fund (QVOPX) invests in long-short equity, long-short credit and long-short macro. The macro portion includes currencies, commodities and sovereign debt. “We call it long U.S. dollar, short everything else,” she says. “We think there’s less tail risk here.”
She is concerned that slowing growth in China could lead the country to further devalue its currency—and the impact of that, she says, could ripple to China’s trading partners Thailand and Japan. She thinks Europe and Japan have too much leverage, which she says could be a long-term drag.
Davis of LMCG Investments views market neutral as a great starting point for investors looking for little or no relation to the stock or bond markets. “The category is not the most exciting from a total return perspective,” he says, but it can outperform stocks and bonds during market disruptions.
Three years ago, LMCG Investments converted its global market neutral strategy from a limited partnership into a mutual fund. The fund (GMNRX) is designed to provide Treasury yield plus 3% to 4% on a fairly consistent basis, he says. LMCG is looking to bring more liquid alt teams to the firm.
Amato is pleased to see some flattening out in the liquid alts space. “There was definitely too much growth, too much product,” he says. “There needs to be, I won’t say consolidation, but rationalization.” In other words, does a fund make sense and is its return worth it?
The strategies he’s a little more excited about are global macro and equity hedging. They tend to translate better from the hedge fund world to the mutual fund world, he says. The translation is harder for event-driven strategies, he adds.
Stronger Vetting
Thomas Meyer, CEO of Meyer Capital Group, a fee-only RIA firm based in Evesham, N.J., anticipates a market correction and is using alternatives as diversifiers and “shock absorbers,” he says. “My biggest worry is an absolute herd of elephants is going to run through that little door.”
But his firm, which wraps liquid alternatives around cheap ETFs, has pared down its liquid alt universe and slightly reduced its allocation to these strategies. Liquid alts now account for roughly 10% of its more than $800 million of assets under management. “There’s a lot of junk out there and advisors have to be wary of this,” says Meyer. “You have to do your due diligence.”
“The highway is littered with the carcasses of great alternatives managers who went from the non-liquid platform to the liquid platform and they failed,” he adds, noting that maintaining daily liquidity is a huge challenge. One fund that saw its flows skyrocket and then plunge, he says, was the Marketfield Fund (MFLDX). Meyer Capital Management once had a very large position in it.
Among the funds Meyer Capital Management currently uses for diversification are the Vanguard Market Neutral Fund (VMNFX), the Boston Partners Long/Short Equity Fund (BPLEX), the Boston Partners Long/Short Research Fund (BPRRX), the Guggenheim Macro Opportunities Fund (GIOAX) and the Pimco Income Fund (PONDX).
Educating clients about beta and how liquid alts can offer downside protection helps temper their resistance to the higher fees, says Meyer. “It’s not just about the indexes or the alternatives,” he tells them. “We’re molding the two together.”