Liquid alts funds pass first real test with flying colors

Reducing downside risk as traditional strategies bite the dust amid market meltdown.

It’s been a long time coming, but alternative-strategy mutual funds are finally getting their day in the sun as the dark clouds gather over the traditional investment strategies.
As Friday and Monday stacked up two of the most volatile days for stocks since the start of the current bull market, liquid alternative mutual funds performed pretty much as advertised.
Of the seven liquid alt mutual fund categories tracked by Morningstar Inc., the worst performer on Friday, when the S&P 500 Index dropped by 3.13%, was a 1.41% drop for long-short equity funds.
The next worst performer was multi-alternative funds, which declined by 78 basis points.
Large-cap growth funds, on the other hand, dropped 3.26% on Friday.
On Monday, when the markets saw even more extreme gyrations that ended in a 3.94% drop for the S&P 500 index, liquid alts again held their own.
With a 1.86% decline, the long-short equity category was the worst performer, while multi-alternative was down 1.01%. Large-cap growth funds fell 3.73%.
“We’ve been preaching that we can protect on the downside, so if we fail now it’s not a good category,” said Bradley Alford, who manages the Alpha Opportunistic Alternatives Fund (ACOPX), which was down 70 basis points on Monday and is off just 1.4% from the start of August.
As stocks rebounded sharply to start the day on Tuesday, Mr. Alford acknowledged that most strategies designed to reduce downside risk will not be able to keep up, but that’s part of the agreement that most investors of liquid alts have grown to understand.
Winning by losing less is a theme that the liquid alts space has long embraced, but over the past six years, most of the strategies haven’t been able to prove the point. Until now.
BENEFITS BECOME APPARENT
“Hedges and short positions contribute the downside protection, and this is the environment where those benefits become most apparent,” said Michael Hennen, director of portfolio management at Hatteras Funds.
“When we talk about the power of compounding, we’re talking about how much you need to get back to even after a 10% loss,” he added. “We’re definitely seeing that the volatility in the markets is helping investors to think more about risk, and the more they think about risk the more they think about the benefits of alternatives.”
During the stock market carnage of the past few days, some long-only strategies with larger cash balances did better than fully-invested funds, which has led to some investors making the case for cash as a down-market hedge.
The trouble with that strategy is, unlike most alternative strategies, there is virtually no upside to cash as an investment.
With the exception of bear market funds that are designed as a constant bet against positive stock performance, most liquid alt strategies have been lagging but still delivering some positive performance throughout the bull market cycle.
This year through Friday, the long-short equity fund category has declined by 3.54%, multi-currency funds are down 3.04%, multi-alternative funds are down 2.01%, market neutral funds are down 95 basis points, nontraditional bond funds are down 58 basis points, managed futures funds are up 1.24%, and bear market funds are up 6.89%.
Over that same period, large-cap blend funds are down 7.3%, large-cap growth funds are down 4.14%, and the S&P 500 is down 6.81%.
PERFORMANCE CAN VARY WIDELY
One caveat when it comes to liquid alt funds is that performance within categories can vary widely, placing an additional onus on financial advisers to research and choose wisely.
For example, the AQR Managed Futures Fund (QMHIX) gained 4.15% on Monday, while the category averaged a gain of 6 basis points. The Hussman Strategic Growth Fund (HSGFX) gained 2.8% on Monday, while its market neutral category declined by 46 basis points. The Glenmede Secured Options Fund (GTSOX) declined by 5.5% on Monday, lagging a 1.86% decline by the long-short equity category.
Even high-profile investors like Bill Gross are not immune to being caught flat-footed during dramatic market moves.
Mr. Gross’ Janus Global Unconstrained Bond Fund (JUCIX) fell by 2.86% on Monday, while the nontraditional bond category fell by just 48 basis points.
“The pummeling in the markets has mostly been concentrated to the equity space, so I’m not sure why that fund did so much worse than even a long-only bond fund,” said Todd Rosenbluth, director of mutual fund and ETF research at S&P Capital IQ.
Janus representatives did not respond to a request for comment.
The long-term bond fund category declined by 14 basis points on Monday, while the Barclays U.S. Aggregate Bond Index declined by 3.03%.
“I don’t know exactly what’s in Bill Gross’ fund, but it is a fund that can go anywhere,” Mr. Rosenbluth said. “As an unconstrained fund, you wouldn’t expect it to do so much worse than constrained funds.”
Whether talking about liquid alts or actively-managed long-only strategies, Mr. Rosenbluth stressed that it is never a good strategy to invest based on how a fund performs over a few days of extreme volatility.
“However, yesterday was a good guide in terms of how a strategy will likely perform during times of stress,” he said. “Monday was just one day, but it will show you if you’re getting any bang for your buck.”