As the stock market continues its push to new record levels, multialternative mutual funds have been enticing investors and advisers with the chance to hedge some of the mounting risk.
The broad category, represented by 120 mutual funds, almost a third of which have been launched in the past 18 months, has swelled to $33.8 billion in total assets, up from $28.9 billion at the start of the year, and nearly double the amount from 18 months ago.
A large part of the appeal is the seemingly investor-friendly and catchall feel of a multialternative strategy that lets investors and advisers easily add alternative exposure to a portfolio.
But a look under the hood of the products in the category shows that these mutual funds, which invest in several different underlying alternative strategies, are not all created equal, and that places extra emphasis on due diligence.
Morningstar representatives acknowledge that the category has gotten cluttered with funds that don't easily fit elsewhere, such as the $3.6 million Alps Real Asset Income Fund (RAEIX), which is the year-to-date category leader with an 11.9% gain through July 14. That compares with a category average gain of 1.65% over the same period.
The other end of the category finds the $28.4 million Salient Alternative Beta Fund (SABAX) with a decline of 17.8% year-to-date through July 14.
Looking only at those funds that best fit the category as offering diversified alternative-strategy exposure in the form of a fund of funds, one of the biggest distinctions relates to whether the underlying portfolios are allocated to other registered alternative mutual funds or to separately managed accounts that are often managed by hedge funds or other private money managers.
From a marketing perspective, there might be an advantage to touting a multialternative mutual fund that is allocated to hedge fund separate accounts.
But that edge doesn't always show up in the performance numbers.
Of the 45 funds in the category that allocate assets to outside funds and money managers, those funds using underlying registered mutual funds have averaged better performance over the past few years.
On a three-year annualized basis, six of the top 10 multialternative funds allocating to outside managers are investing in registered mutual funds as opposed to hedge fund separate accounts.
On a trailing 12-month basis, the funds of mutual funds hold seven of the top 10 spots, and year-to-date through July 14, funds of mutual funds make up half the top 10 funds.
Meanwhile, over each time period, only one fund of mutual funds lingers among the 10 worst-performing multialternative funds that use outside money managers.
Morningstar fund analyst Jason Kephart said part of the performance edge could be attributed to the fact “a lot of the '40 Act funds might be using a broader definition of alternative” that could enhance performance.
But chasing performance wouldn't necessarily be unique to funds of mutual funds, he added.
“Some of the underlying managers also run hedge funds, but that doesn't mean they're better portfolio managers than somebody who doesn't run a hedge fund,” Mr. Kephart said.
Bradley Alford, chief investment officer at Alpha Capital Management, believes the performance gap relates to the type of hedge fund managers the multialternative mutual funds are able to attract to run the underlying separate accounts.
Citing the typical hedge fund fee structure of 2% on assets and 20% on performance, Mr. Alford asked, “What good 2-and-20 manager is going to take a pay cut to manage money for a mutual fund?”
“I think they're getting adverse selection, because they're getting the B-level managers who aren't good enough to charge 2% and 20%,” he added. “And if you do have a manager charging 2-and-20 in his hedge fund, do you think he's going to put his best ideas in the separate account he's managing for 1%?”
The category average expense ratio is 1.83%.
Mr. Alford admittedly has a dog in the fight as the manager of two multialternative funds of mutual funds, Alpha Defensive Alternatives (ACDEX) and Alpha Opportunistic Alternatives (ACOPX), each of which hover near the top performers.
Andy Dudley, senior portfolio manager at Context Asset Management, acknowledged some of the performance disparity but insisted that investors should be paying attention to the quality of the underlying portfolio managers in a strategy designed to be diversifier.
“To the extent that some funds have exposed themselves to traditional market risk, they have won in these markets,” he said. “Strategies that have leaned with the market will populate the upper end of the performance spectrum.”
Mr. Dudley manages the Context Alternative Strategies Investor Fund (CALTX), which was launched in March as a strategy that allocates to separate accounts.
“In some cases, these multistrat funds are trying to mix a full range of asset class exposures,” he said. “We're trying to get at the skill and the value of the individual subadviser to actually generate alpha.”
Stephen Mason, manager of the $150 million Collins Alternative Solutions Fund (CLLIX), said he believes such alternative strategies benefit from allocating to underlying hedge fund managers.
“I've never fully understood the idea of using '40 Act funds as the underlying investments,” he said. “When you're using '40 Act funds, they are limited to the '40 Act rules.”
That's exactly the point, according to Mr. Alford.
“Funds that use separate account managers might have a great manager behind the curtain somewhere,” he said. “But the advantages of using '40 Act funds is daily liquidity in underlying funds that are all following the '40 Act rules.”