Using hedge fund strategies in a mutual fund can offer risk-adjusted returns and a way to bail out to cash

March 8, 2012 — 4:18 PM UTC by Guest Columnist Jon Sundt


One of the primary legacies of the crash of 2008 is investors’ desire to manage risk in their portfolios better by reducing volatility and enhancing liquidity—and to do so without sacrificing returns. For advisors seeking to help their clients meet this challenge, the emerging class of liquid alternative investments represents a compelling potential solution. See: The top 10 alternatives to alternative investments.

Liquid alternatives offer traditional hedge fund strategies in a mutual fund format — with its implicit daily liquidity, low investment minimums, no investor pre-qualifications, and efficient tax reporting. This rising class of products is designed to help investors of all stripes access the diversification benefits and strong potential risk-adjusted returns of hedge funds that traditionally have been the purview of institutions and high-net-worth individuals. See: How RIAs can best pick alternative investments: Punt.

While hedge fund strategies have been migrating to a broader investor base for some time, that trend has accelerated since the crisis. According to a McKinsey & Co. report published in November, alternative mutual funds and exchange-traded funds account for approximately $240 billion of the $11.62 trillion in total U.S. retail fund assets. More than 70 new alternative mutual funds were launched in 2011—an increase of 24% in the Morningstar Alternatives category, which totaled more than 300 funds as of year-end.

In discussing the benefits of these products with their clients, advisors should focus on the following key themes:

Liquid alternatives investments offer a more flexible means of pursuing strong risk-adjusted returns than less-liquid alternatives—yet both can play key roles in a well-diversified portfolio.

Liquid alternative investments can provide investors with the ability to mitigate market volatility and enhance returns, while also meeting increasing demands for more transparency and liquidity than are offered by hedge funds typically accessible via private placement.

Indeed, alternatives in a mutual fund format differ substantially from private hedge funds with their daily pricing and liquidity, 1099 tax reporting, and extensive regulatory requirements.

Diversifying alternatives

One of the many deleterious effects of the financial crisis was that it forced investors to liquidate some of their better-performing assets to fund immediate spending needs. See: How the Harvard and Yale endowment models changed to avoid a repeat of 2009.

But by diversifying sufficiently to liquid alternatives, investors can also maintain their exposure to less-liquid hedge fund strategies that offer higher risk—and potentially higher returns. In this way, liquid alternatives and private-placement hedge fund investments can work in tandem to position broader portfolios to generate potentially strong risk-adjusted returns in up and down markets.

In this context, it is important that investors keep in mind that even the best investments suffer periods of underperformance. Thus, advisors must help prevent investors from fixating on tick-by-tick pricing swings at the expense of a long-term perspective.

Liquid alternatives facilitate access to proven hedge fund strategies, offering strong risk-adjusted return potential and portfolio diversification benefits.

Another lesson of the crisis is how highly correlated markets can be in a downturn. Thus, the ability to generate returns that are uncorrelated to traditional asset classes is crucial both for weathering short-term market swings and meeting long-term investment objectives. While past performance is certainly not indicative of future results, the table below illustrates the marked difference between the risk-return profiles of U.S. bonds, U.S. equities and three prominent hedge fund strategies—managed futures, global macro and long/short equity—increasingly available via mutual funds, as well as the potential diversification benefits of these alternative asset classes. See: AI Exchange to offer hedge fund-like investments in managed-account form through Schwab, Fidelity.

Partnering with an advisor with alternative investment expertise can provide an entrée to the premier hedge fund managers via a mutual fund format.

With the universe of managers accessible via mutual funds expanding rapidly, the challenge for advisors is to find the most talented ones and determine a method of accessing them. That means there are clear benefits from partnering with firms such as Altegris (of which I am president) that can source the premier alternative investment managers globally.

The growth of alternative mutual funds has spurred a number of long-only managers to expand their mandates to include hedging. However, investors realize the full benefits of liquid alternatives only when they access proven, top-flight hedge fund managers providing alpha through customized versions of their strategies—rather than mutual fund managers who might supply nothing more than glorified market beta.

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Figure 1

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Figure 2


All three of these hedge fund strategies offer a high degree of transparency and trade in relatively liquid instruments, thus making them strong fits within a mutual fund structure.

By gaining exposure to premier alternative investment managers, investors can inject their portfolios with more flexibility, lower correlations to stocks and bonds, and improve their risk-return profiles. Within this framework, liquid alternatives can help clients rest easier in the short-term—while also advancing their longer-term investment goals.

_Jon Sundt is president and CEO of Altegris, which offers alternative investments via a suite of private funds, actively managed mutual funds and futures managed accounts to financial professionals and individual investors. Altegris and its affiliates are subsidiaries of Genworth Financial Inc. and are affiliated with Genworth Financial Wealth Management. _

*Past performance is not indicative of future results. The referenced indexes are shown for general market comparisons and are not meant to represent any particular fund. An investor cannot invest directly in an index. Moreover, indexes do not reflect commissions or fees that may be charged to an investment product based on an index, which may materially affect the performance data presented. There is no guarantee an investment will achieve its objective, generate profits or avoid losses. Managed futures represented by Altegris 40 Index©; global macro represented by Barclay Global Macro Index, equity long/short represented by HFRI Equity Hedge (Total) Index; U.S.stocks represented by S&P 500 TR Index, U.S. bonds represented by Barclays Aggregate Bond Index. AROR: annualized rate of return. AStDev: annualized standard deviation. Standard deviation is a statistical measure of how consistent returns are over time; a lower standard deviation indicates historically less volatility. WDD: worst drawdown. Drawdown measures the peak to valley loss relative to the peak for a stated time period. Sharpe: Sharpe ratio. Sharpe ratio measures return in excess of the risk-free rate, per unit of risk, as measured by standard deviation. Source: Altegris.

Certain affiliates among the Altegris Cos. act as investment adviser to, or as a distributor of, alternative strategy mutual funds that provide investors access to certain alternative investment strategies and managers through a traditional mutual fund format. Investors should carefully consider the investment objectives, risks, charges and expenses of any mutual fund. This and other important information about any mutual fund is contained in the fund’s prospectus and should be read carefully before investing.

Mutual funds involve risk, including possible loss of principal.

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Manager Research
Top Executive: Jon Sundt

Share your thoughts and opinions with the author or other readers.


Elmer Rich III said:

March 8, 2012 — 6:22 PM UTC

Is there any data on the demand, and its growth, for alternatives – independent of growth in products?


Mike Dever said:

March 9, 2012 — 1:10 AM UTC

Managed futures offer some of the best portfolio diversification value of any investment; and diversification is the one true “Free Lunch” of investing (meaning it provides the ability for an investor to earn both greater returns and less risk). But if a person starts with just considering long stocks, bonds and real estate as being the only portfolio options, then true diversification cannot be achieved. That’s why managed futures are so important. I discuss this throughout my book “Jackass Investing: Don’t do it. Profit from it.” (#1 Amazon Kindle best-seller in the mutual fund category).

My approach to diversification is quite different from conventional investment wisdom, however. One concept I think you’ll find most interesting is in that I replace asset classes with “return drivers” and “trading strategies” (as I point out in the book, asset classes are simply long-only trading strategies that do not attempt to disaggregate their many separate return drivers). Once viewed in this fashion it is easy to create a truly diversified portfolio, rather than one constrained by the shackles of asset classes.

I’m pleased to provide a complimentary link to the final chapter of the book, where I present the benefits (greater returns & less risk) of a truly diversified portfolio:


Turnkey rentals said:

July 27, 2012 — 9:04 AM UTC

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