The numbers behind the case for alternatives

A pickup in market volatility can be a good time for a refresher on how various asset classes have performed during periods of market turmoil.
During the financial crisis, for example, alternative strategies generally outperformed their traditional counterparts. But it’s no sure bet that all alternatives will weather every market storm, or that all traditional investments will buckle under when the going gets rough.
From October 2007 through March 2009, the time span of the financial crisis, as the Federal Reserve pumped $29 trillion worth of bailout funds into the system and 8.8 million people in the U.S. lost their jobs, most investment categories suffered double-digit declines.
Because the market meltdown was founded in mortgage defaults and failed investments in mortgage-backed securities, it is not surprising REITs took the biggest hit with a category decline through the period of nearly 64%.
On the traditional investment side of the ledger, only investment grade bonds survived the period on the positive side with a 4.7% gain.
Alternative-investment categories did much better. Managed futures led the field with a gain of 16.5%, followed by gold, which gained 16.3%.
Global macro strategies managed at 1.8% gain.
The biggest losers among alternative strategies were commodities, which dropped 25.1%, and long-short strategies, which fell by 17.6%.

Credit crisis

Source: RCM Alternatives

On Sept. 11, 2001, when terrorists flew planes into the World Trade Center in New York and the Pentagon in Washington, D.C., financial markets suffered an abrupt jolt. Once equity trading resumed following the attack, the S&P 500 lost 11.6% over the first five days of trading, but finished the one-month period down 8.2%.
The biggest loser on the traditional side was small-cap stocks, which dropped 13.4% as measured by the Russell 2000 Index.
Across traditional investments, REITs, bonds, international and domestic equities, and private equity all finished the period negative.
On the alternative-investments side, gold predictably gained 3.7%, while global macro and risk arbitrage strategies each gained 1.7%. Commodities, which includes oil, suffered the biggest drop with a loss of 4.8%.

9/11 tragedy

Source: RCM Alternatives
The bursting of the tech bubble, over the period from March 2000 to September 2002, triggered some extreme performance disparities among the various asset categories.
REITs shot up by 49.5% during the period and investment grade bonds gained 19.7%. But developed international stocks lost 46.5%, U.S. large caps lost 40.3%, and U.S. small caps lost 30.3%.
The tech bubble period was marked with such extremes as 194 public stock offerings’ doubling in price on their first day of trading. The tech-heavy Nasdaq Composite Index gained more than 400% during the five years leading up to the 2000 market crash.
Investors savvy enough to hedge the market risks did well in the wake of the bursting tech bubble.
Global macro strategies gained nearly 45%, managed futures strategies gained 21.5%, and risk arbitrage gained 11.4%.

Internet bubble bursts

Source: RCM Alternatives
In the summer of 1998, most regular investment types had never heard of Long-Term Capital Management, a hedge fund run by a couple of Nobel laureates. But that changed in a hurry.
With $7 billion in assets, LTCM, as it was known, was one of the largest hedge funds ever and its size was amplified by a debt-to-equity ratio of 25-to-1, which quickly turned small losses into catastrophic losses.
The two-month meltdown included a 44% decline in August 1998, and the fund ultimately had to be bailed out by the Federal Reserve to prevent an even bigger impact across the financial markets.
After it was learned that the fund lost $551 million on Aug. 21 alone, LTCM became known as Long-Gone Capital Management.
Traditional and alternative strategies alike suffered during this brief period.
On the traditional side, only investment grade bonds could stay positive at 0.78%. Among the alternative strategies, managed-futures funds gained 5.6% over the two-month stretch. The biggest hits were suffered by U.S. small-cap stocks (down 26.1%), REITs (down 15.8%) U.S. large caps (down 15.6%), and international equities (down 12.4%).

Long-Term Capital Management goes under

Source: RCM Alternatives
In stark contrast to the Federal Reserve’s present practice of warning, then warning some more on the chance of an interest rate hike, in early 1994, the Fed made the mistake of catching markets and investors by surprise and the reaction was not pretty.
When then-Fed Chairman Alan Greenspan bumped rates to 3.25% from 3% in February 1994, markets banged through a five-month stretch that the current Fed board probably recalls every time it considers a rate hike.
The yield on the 30-year Treasury bond jumped from to 7.75% from 6.2%, effectively cutting the bonds’ value by $600 billion.
Private-equity investments gained 3.93% during the period, but all other traditional asset classes took a hit. Among alternative categories, long-short, risk-arbitrage and hedge funds in general each lost between 7.8% and 9.4% over the five months following the rate hike.

Surprise Fed rate hike

Source: RCM Alternatives
Across the five crisis periods, the median performance of managed futures stood out with a 14.3% gain, followed by 1.2% for global macro strategies.
But on a total-return basis, private equity led the pack at more than 14%, and with around 11% volatility over the combined periods.
REITs and commodities were most volatile, particularly compared to weak performance.

Median performance across five crisis periods

Source: RCM Alternatives
Here are the indexes used:
Managed futures: DJCS Managed Futures Index
Bonds: Morningstar U.S. Market TR Index
Junk bonds: Barclays U.S. Corporate High Yield TR
Commodities: S&P GSCI Enhanced Commodity Index
Private equity: Cambridge Associates U.S. Private Equity Index
REIT: MSCI U.S. REIT Index
Hedge funds: DJCS Hedge Fund Index
Global macro: DJCS Global Macro Index
Large cap: S&P 500
Small cap: Russell 2000
Long/short: DJCS Long Short Index
Risk arbitration: DJCS Risk Arbitrage Index
Gold: Spot price
International stocks: MSCI