Liquid Alts

Originally I started talking about this topic in the CFA general discussion but i believe this may be more approrpriate.

Does anyone have experience with liquid alternative mutual funds? I’m trying to better understand the risk/return profile of the various strategies to find out which ones can actually replicate their private placement counterparts. I have issues with the structure of various strategies, such as managed futures, and I’m curious if certain regulatory restrictions will cause these strategies to perform poorly during a market crisis when investors rely on them the most.

I’d be very interested to hear from someone who can help me understand why the Aberdeen Diversified Alternatives fund, which invests in a variety of strategies (L/S Equity, Real Assets, Opportunistic FI) has a .9 correlation with the S&P 500 from Jan 06 to Jul 2011. The correlation becomes smaller as you expand the period covered to today, but that is because the fund has massively underperformed the S&P over the last three years. Now this is fully expected, because alternatives aren’t designed to capture the large returns during a bull market, but the fund has nearly identical returns to the S&P over the 06-11 time period. This is a time period in which alternatives should have been shining, and protecting the value of client assets.

Alternatives is such a broad asset class — it really depends on the underlying strategy the manager is following. The more liquid of the alternative asset classes (L/S Equity, L/S Credit, Merger Arb, Global Macro, Managed Futures, etc) can be run in a 40 Act structure very easily and can be managed in the exact same manner as their private fund counterparts. Other strategies such as distressed debt obviously don’t work in the mutual fund structure.

Another thing to think about is the way in which the manager approaches the strategy. 1940 Act Mutual Funds have rules surrounding things like diversification and liquidity so a manager who runs their book extremely concentrated or traffics in micro cap type names may not be able to run their strategy in this structure.

In regards to your question about the specific fund, I would agree, you wouldn’t generally see an alternative fund basically equal the market in a period like 2008. However, I would be careful not to draw any conclusions about liquid alts as a category based on this one fund. Its quite possible they just did a poor job managing the fund (For example the Morningstar Long/Short Equity category average was -15.4% during 2008 against -37% for the S&P). One thing I would point out is that most of the liquid alt funds that have long track records are not run by established atlernative investment shops — many were started by long only firms that realized they could raise assets by adding “alternative” to the name. As the category matures and many big name alts shops realize this is the future and join the fray you should see performance come more in line with private fund track records.

BC, thanks for the input.

It seems shocking to me that a fund, made up of 8 different alternative strategies including fixed income opportunities, real assets and managed futures, could have a correlation of 0.9 and the exact same return as the S&P 500. I can’t find one that has performed well so hopefully you’re right and the good managers are the ones coming into the field now.

Can you point out a managed futures fund that has performed well? It seems to me that funds such as the Altegris Managed Futures Strategy Fund would have to generate extrodinary returns to justify their risk. This fund takes 6% upfront, 4% management fee and has a 20% incentive fee… a lot of things have to go right for the investor to make any money off of an investment with that structure.

That’s not really surprising. You might be thinking of market neutral strategies. They’re in their own Morningstar category and in '08 they returned -0.33%.

I wasn’t implying that it was surprising… I was actually using that as a point to say the category has performed within expectations and that one fund was the outlier

BC, do you have a link to the morningstar category average? I don’t think it’s relevant to compare a L/S fund to a diversified fund, but I’m just curious where you’re getting that number. When i go on Morningstar and view the L/S equity funds, the only one that has a long enough track record is the Guggenheim L/S Equity Fund RVSRX, which also has near perfect correlation to the SPY from 2006-2011

Look at any fund in the category - for example:

The category averages are easily found there. Also, it’s not really unusual for a long/short fund to be highly correlated to the S&P. Most L/S funds out there are 130/30 funds or something similar. You still end up with a beta around 1 unlike the market neutral strategies where they strive to keep the beta (and correlation) at 0.

I just threw out the long/short category as an example. Maybe a more appropriate universe would be the Morningstar Multi-Alternative Universe – category average of -22.14% during 2008.

Regardless, the universe of liquid alternative funds is growing every day and I would make the argument that there are much more high quality funds coming online today than there have been in the past as we see established hedge fund managers move into the space. But, even today there are a good number of quality funds with decently long track records — you just have to find them!

^Yeah, I’m not debating you. I was just responding to OP’s concern about correlations being high. Just because something is labeled an “Alt” fund doesn’t mean it’s uncorrelated. There’s a good chance it is, but it’s not a requirement. Long/Short funds are very misleading. A 130/30 fund is still net 100% long so while it’s labeled as an “alternative” it’s really a lot like a long only fund.

Anytime you lump managed futures, market neutral strategies, long/short, merger arb, etc. all in one category - “liquid alts” - you, understandably, get a lot of confused advisors.

Sweep the leg,

I think it’s pretty easy to understand how a L/S fund would have high correlation to the S&P. Getting back to the original post, the Aberdeen Diversified Alternatives Fund, how can that possibly have a .9 correlation to the S&P if the strategies are executed as advertised. Take a look at the SPY from 1/1/2006 - 1/1/2012 and compare to GASAX


I agree and I believe it will be the funds that are replicated by well known existing private placement funds that perform the best. I still have a distrust for strategies such as managed futures though. The next big market correction will be key to this new and growing segment, if they fail as badly as that Aberdeen fund I think there will be big pushback from investors. Especially because these funds are now targeting investors that are much less wealthy

Here is where the question comes in. Can the strategies be executed with the same effectiveness as they are in the private fund world. I believe for the vast majority of strategies the answer is yes. I’m sure we could find quite a few examples of diversified HFoFs that did not perform as expected during that period either.

Unfortunately, most retail investors do not have the right expectations for how an alternative fund SHOULD perform and will continue to judge their performance against the S&P like we see all to often with the media bashing on hedge funds. These funds are a great addition to most investors portfolios if they can figure out how to use them correctly and not sell everytime they don’t keep up in an up 20% market.

^ This is so right.

If I’m an advisor I just don’t think I could put my clients into these products without some proof that they can work. I would expect my allocation to a multialternative fund to provide diversification and limit losses during times like 2008. However, if I had pitched that to my client in 2007, id be fired by 2009 because those portfolios performed exactly the same as the S&P. I could have told them how fixed income arbitrage works, told them about real assets and opportunistic lending, how managed futures are supposed to be able to profit reguardless of market direction…one of that mattered. Peak to trough the S&P lost 56% while these multialternative funds performed just as poorly: GASAX (-57%), AAAAX (-41%), APHCX(-41%), AVGAX (-48%), BNAAX (-65%). Morningstar can say multialternative mutual funds performed well in 2008, I just flat out don’t believe them. Where’s the proof? Did all these sucessful funds subsequently close during the bull market?

I found two funds that performed well. VPDAX, which has a return of 15% over the past 6.5 years. It didn’t sink but it certainly hasn’t made money. They invest in FI, equity and real estate, yet somehow have steady 2% gains per year. The Absolute Strategies R fund performed exactly as i would have expected in the 2006-2012 period. If this was the normal return for multialternative funds, I’d be a believer.

Unfortunately I don’t think we can just tell advisors that the good managers were’nt around this space during 2008 and next time will be better. I guess my real takeaway here is that in order for an advisor to do right by his/her client, they’ll have to find a good alternative investment manager that is now introducing a liquid mutual fund, and hope that they are going to be able to properly replicate the results.

*I’m sure there were private placement FoHF’s that performed poorly in 08, but I would hope that the majority of them were able to at least beat the S&P.

**I too get very annoyed when I see articles such as “Hedge Funds underperform for 4th straight quarter” when the S&P is up 25%. Of course they’ll underperform, there not designed to outperform equities in a market like that. I am very active in making sure that our advisors who decide to place clients in hedge funds do so to better diversify the portfolio, rather than chase big gains.

Look at the underlying funds Aberdeen uses. None of them are really what we (institutional sales people) would sell as “non-correlated” asset classes. Global macro, opportunistic debt, long/short, and even REITs are all highly correlated to the S&P, particularly over the last five years.

The objective of the fund is to provide steady growth with low volatility and low beta. The growth has been pretty good, but their beta is a little higher than I’d expect.

Bottom line is, when dealing with liquid alts you have to look under the hood before you buy. Just because something says it’s “diversified” doesn’t make it so. In this particular case, I’d say you get good exposure to different alternative styles, but performance-wise, they all generally point in the same direction.

I guess I didn’t think opportunistic debt would be highly correlated to broad equity markets, learn something new everyday. I was looking at that allocation as basically 50% uncorrelated assets (cash, real assets, opportunistic debt, systematic… to a lesser extent event driven and opportunistic equity, since I’d expect a correlation of maybe .8)

Since we don’t know if the allocation has changed since 08, I guess we can’t really analyze it anyways. Maybe equity l/s was a more dominant position in the portfolio back then. Who knows. But if the strategy was the same and you’re telling me that these asset categories are highly correlated to the S&P, then it makes perfect sense that they performed nearly identically through those years. Interesting that it’s performed so poorly the last few years tho. Getting the worst of both worlds with this fund.

STL, it’s looking more and more to me like it’s the manager that counts, not the stated strategy. Check out these holdings…

This fund has an even larger allocation to equity based strategies (assuming the strategy stays constant throughout the past decade, which is doubtful) and they performed well during 08.

This reinforces the point that BrewCity is trying to tell me, that once the smarter managers come into the field, we may see better results. I still worry that too many of the duds are going to get money thrown at them because their strategies say that they are in traditionally uncorrelated asset classes.

^Perhaps, the the Morningstar “multi-asset alternatives” as a whole has a correlation of ~.9 to the S&P. That’s just not the category to fish in for non-correlated strategies.

Liquid alts get no AUM. Marketfield and Arden are the only two (other that strat income funds, not really alt). Those two got a bunch of AUM and everybody starts talking about liquid alts AUM growth rates. With 20% annualized on the 5 year S&P return, people aren’t going to be interested in making a new allocation to liquid alts. Not hard to understand. Anybody think different?

Um, that’s completely inaccurate. Liquid alts are getting a ton of assets and expected to raise more on an exponential scale. Everyone is looking for fixed income alternatives; something with similar volatility and expected returns. What can give you low vol and 4-6% a year? Market neutral and (some) long/short strategies. The allocation is coming from fixed income, not equities.

It’s, by far, the most talked about asset class right now. Just got back from conference and every other session was on Alts. Though, non-traded alts are also very fasionable as well.