Liquid alt mutual funds are restricted to 33% leverage, which could theoretically cause problems during a period of crisis.
If a fund has $100M, they could use $33M in leverage. A 15% fall in assets puts the fund at (133*.85) $113M, with $33M in leverage and $80M in underlying assets, or a 41.25% leverage ratio. The legal leverage at $80M of assets is $26.4, implying that the fund would have to sell off $6.6M of investments to pay back their loan.
So in a ‘crisis’, liquid alt funds that perform poorly and are fully leveraged would be forced sellers of depressed investments. Does anyone have familiarity with this issue? I’d imagine they are using swaps and other derivatives to create implied leverage which is unregulated, but if not this could be a big issue in the future, especially in an '08 type of scenario.
Well, it’s 30% _ net _ leverage and you’re only going to run into those within the long/short fund category (for the most part). Even then, there aren’t many long/short funds that take that big of a bet. Most of them still hover around 100% long. The funds that do take more material long or short bets are generally paired with other funds to create a multi-asset liquid alt fund.
A few things are accomplished here. First, just about every liquid alt (except long/short) should be uncorrelated to the market so a major correction shouldn’t have any impact on it. Second, the liquid alts that are selling well right now are fund-of-funds so the manager chooses strategies with different return profiles to mitigate this risk.
So, yes, your scenario could be a problem for a manager running a single fund that uses his/her full 30% long or short bias…but that’s very rare. The ones that do aren’t generally sold as standalone products, but rather, they seek distribution by getting a sleeve in a multi-manager FoF. And, in theory, an '08 scenario is the exact reason why people should own Alts.
Now if we want to talk about August '07 that’s a different story altogether…
I was wondering if I was calculating that leverage correctly. The rule is 300% asset coverage, so would that mean that the fund could actually borrow $50M? They’d then have $150M in assets and $50M in borrowings.
I’m suprised to hear that leverage usage isn’t that common. I would think they would be trying to maximize returns in any way possible, especially with implied leverage.
I just learned about the idea of using multi-alternative funds to combine high and low liquidity strategies to stay within the legal boundries (I believe they must be able to liquidate all investments within 7 days). However, it seems in practice that these multi-alternative funds are over-diversifying and producing equity like volatility. Below are the peak to trough drawdowns of several popular multi-alternative funds. They had drawdowns between negative 2.5 - negative 5% over the past month during the recent pullback. I’m wondering what makes these funds such underperformers, because they certainly aren’t catching much of the upside either. I understand that alternatives are not designed to perform like equities, but these types of funds certainly do during times of market volatility, which seems to be the opposite of what they’re designed to do.
To clarify, the drawdowns above are from early '08 to march of '09.
Morningstar’s strategy performance shows L/S Equity at -20% drawdown, market neutral at about flat, managed futures up 10%. The multialternative category shows a -28% drawdown. There aren’t categories for event driven or alternative credit, but it seems strange that the multi-alternative is a worse performer than the combination of all strategies…
Right, but the multialternative funds are still performing poorly, why? Shouldn’t the diversification of strategies produce a smaller drawdown? If L/S is down 20%, M/N is flat and managed futures were positive, then how are all these reputable funds seeing drawdowns of 30% or more?
I’m getting a strong sense of Deja Vu. This exact topic was discussed on here just a month or two ago. Anyway, what I was getting at is the problem is Morningstar’s “Multi Alternative” category is way too broad and they recognize this. They throw any fund-of-funds in there regardless of their objective.
Just take a look at these three Virtus funds - VATIX, VIASX, and VAIIX - Total Solution, Inflation-Solution, and Income Solution respectively but all categorized by Morningstar as Multi Asset Alternatives. These three funds have very different objectives and will behave very differently in different market environments, but to someone looking to compare funds based on Morningstar’s categorization, they would think they’re similar funds.
Furthermore, there are way more than just those three categories you’re listing (L/S, MN, and Managed Futures). Depending on how you classify and alternative investment, you’re looking at roughly 30-40 different categories of strategies. The Virtus Total Solution fund has 11 different underlying strategies, for example. Of the 30-40 different categories of alts, just about every one of them was flat or down (sometimes substantially) in 2008. Managed futures might have been the only category to return something materially over 0%.
Another thing to consider, the liquid alt space was tiny in 2008 - literally only several dozen funds (and even more poorly categorized by Morningstar). Indeed, 2008 and the subsequent market environment was the whole reason why we now have several hundred liquid alt funds with new ones being launched every day. Comparing today’s liquid alts market to 2008’s is nearly impossible.
tl;dr - don’t rely on Morningstar to categorize your alt funds. Don’t look at 2008 numbers as 90% of the funds available today weren’t around back then. We’ll just have to wait and see how they do over the next major correction.
The focus on morningstar categories has directed the conversation away from my point. Lets not discuss anything related to morningstar going forward.
Look at the first fund I listed, Aberdeen Diversified. This is a fund of funds that invests in a wide array of strategies. Right now their top 10 holdings are an absolute return fund, L/S equity fund, arbitrage event-driven, tactical opportunities, MLP, managed futures, equity long/short, MSCI JPN hedged, health care fund, preffered fund.
Would you classify this as a multi-asset alternative fund? If not, would you classify either of the other 3 I listed?
The point that I’m making is that the diversified funds are not performing as they should. They have equity like volatility during periods of market turmoil.
Can you list one that performed well in 07-09? I understand that the number of funds has exploded, with many great managers just getting into the ballgame, but I refuse to believe that these will work well in the future based only on that premise. It’s ok if there are 0 diversified liquid alts mutual funds that performed well in 07-09, if you can’t find one thats ok, I just want proof that they can work and haven’t found it.
The more diversified the fund is, the more equity like you’d expect it to be. The more you eliminate specific risk, the more you’re left with a portfolio that behaves like the market, or a risk free bond. I’d expect holding two long/short funds probably has a higher beta than holding one. And that beta would drift towards one the more funds you diversify with.
Well, the only way I can search is using Morningstar so there’s no getting away from it, but there’s still some interesting info to be found.
In 2008, there were 63 multi-alternative funds with only two of them posting positive returns. Cane Alternative Strategies and AMG FQ Global Alternatives returned 7.03% and 4.84% respectively. Cane appears to be gone and AMG is now a 1-star fund. Aberdeen was the worst performing fund in 2008 and is now a 5-star fund…go figure.
In 2009, the number of funds in the category jumped to 105 and only one of those posted negative returns. The top performing fund was JHancock Alternative Asset Allocation fund which posted a solid 41.01%.
From a risk standpoint, as of 9/30/14, the fund sporting the highest 5-year standard deviation and beta is the KCM Macro Trends fund with 13.97% and 1.47 respectively. The lowest in the group is a fund called simply Absolute Strategies with a 2.33% std dev and a beta of (0.01).
With funds in the category that have at least a one-year track record, the best “worst 3 months since inception” goes to Oppenheimer Flexible Strategies which posted a positive 0.04%, while Aberdeen had the worst at (31.59%).
What all this tells me is your not going to find any solace looking at the past performance, nor is it easy to find similarly managed funds to compare. It doesn’t make any sense to have Global Macro and Absolute Return in the same category. I can say from several industry conferences that I’ve attended this year, that the multi-manager funds with an “absolute return” objective are going to be the most popular and they are being advertised as producing expected returns of 5-7% with 4-6% standard deviation. Basically the exact same thing you should get with a core bond fund (over time).
Will they do it? I don’t have the faintest idea.
Edit: Out of the 268 funds in the category currently, only 9 of them have positive returns so far in October. Unsurprisingly, AMG FQ and Absolute Strategies are two of them. And again, unsurprisingly, KCM Macro Trends has had the worst Oct so far returning (5.63%).
The world of alternatives is massive and 5 years from now they’ll be an advisors nightmare with so many strategies and objectives. The multi-alternative funds that claim to be diversified should be analyzed closely because their allocation to varioius strategies may vastly differ from another multi-alt fund with the exact same stated strategy. I think that should be easy enough for advisors to learn and understand.
What I’m worried about is that advisors will still be attracted to multi-alternative funds which claim to do all the work for the advisor and provide a ‘core’ alternative portfolio. If in fact these multi-alt funds are over-diversifying, then these advisors will have a rude awakening during the next period of large volatitlity. I don’t think many advisors are qualified to build their own core of alternative investments, so if a company is able to capitalize on this and design a way to help advisors allocate their capital appropriately, they should see large asset flows in their direction. I see a lot of multi-alternative funds holding a dozen or more strategies, maybe they don’t think they can get away with only holding 3-5 funds. Maybe they’re over complicaticating this? Heck, even a portfolio consisting of equal parts L/S equity, managed futures and opportunistic credit would provide a nice balance to a 60/40 portfolio.