Liquid alt imposters fall to the wayside

Investors continue to ignore market hedging strategies.

Multi-alternative-strategy mutual funds have been quietly fading into the background, reflecting the challenges facing alternative strategy mutual funds.

Of the 31 funds shut down this year across eight liquid alt fund categories tracked by Morningstar, 19 were cut from the multi-alternative category.

While the category is made up of an eclectic mix of investment strategies, it is generally populated with funds that invest in other alternative funds and strategies for diversified exposure to alternatives.

The basic idea is that such funds will be able to navigate periods of market volatility, even if they don’t completely keep pace with the more bullish market cycles.

Trouble is, the bull market hasn’t relented enough for most multi-alternative strategies to strut their stuff. But in periods when the stock market volatility did pick up, some multi-alt funds were exposed as market-beta-hugging imposters that were unable to fend off the stock market’s pullback.

“When you do an analysis of that category you find that a lot of the funds have large equity-beta exposure and lots of credit exposure, which helps them compete with long-only funds,” said Dick Pfister, founder and chief executive of AlphaCore Capital.

Through June of this year, the average multi-alt-strategy mutual fund had a 0.91 correlation to the S&P 500 Index.

“That’s not what advisers are looking for in an alternative strategy,” Mr. Pfister said. “They invest in alts because they want diversification away from equity and credit exposure.”

The third quarter of 2015 stands out as a recent example of where some multi-alternative funds might have been flying too close to the broad market indexes they are marketed as being able to hedge.

During the three-month period from July through September last year, the S&P fell by 6.44%. Over the same period, the average performance of the now obsolete 19 multi-alt funds was a decline of 3.98%.

Some might argue that a drop nearly 2.5 percentage less than the stock market is a solid hedge. But averages can be deceiving. Only one of the defunct funds didn’t lose money in the quarter, and some fell by more than 8%.

By contrast, some of the better-performing multi-alt funds over the past 12 months, managed to shine during the third quarter of last year.

Over the past 12 months, the Vivaldi Orinda Macro Opportunities Fund (OMOIX), the AQR Style Premia Alternatives Fund (QSPRX) and the Dreyfus Global Real Return Fund (DRRIX) gained 9.58%, 7.94%, and 8.24%, respectively. During the third quarter of 2015, the funds increased 1%, 1.6% and 4%, respectively.

Jason Kephart, alternative funds analyst at Morningstar, said one of the best ways to evaluate an alternative-strategy fund is to see how it performs during periods of market volatility.

Ideally, it would be good to check the performance against such market cycles as seen in 2008 and 2011, but a lot of the liquid alt funds don’t have long enough track records. Of the 19 multi-alt funds shut down this year, most were launched since 2013, and only three were around in 2011.

“One of the reasons we’ve been cautious about recommending these funds is that most of them have not been tested yet,” Mr. Kephart said. “You want to see how they act in stressful periods.”
The weaker relative performance, combined with the above average fees charged by most liquid alt funds, has been taking a toll on the category.

While liquid alt funds now represent 486 funds that manage $174 billion, the fund count is down from 500 in December and the asset flows are slowing.

There hasn’t been a new liquid alt fund launched since April, which Mr. Kephart described as a long stretch.

According to Morningstar, six of the eight liquid alt subcategories has experienced net outflows this year through June. Total liquid alt fund net inflows this year through June was $2.2 billion.

That compares to $7.3 billion for all of last year, $15.2 billion for 2014, and $48.6 billion in 2013.

“It just doesn’t seem like a lot of investor think they need anything but a passive index ETF,” said Brad Alford, chief investment officer of Alpha Capital Management.

In April, Mr. Alford sold his Alpha Defensive Alternatives Fund to ValueLine Funds.

Mr. Alford is still managing the $13.9 million fund, which is now known as ValueLine Defensive Strategies Fund (VLDSX).

He said if he isn’t able to sell or grow his other fund, the $9.9 million Alpha Opportunistic Alternatives Fund (ACOPX), he might have to shut it down. “Investors just want to keep up with the market with beta plays,” Mr. Alford said. “It just seems like alternatives managers can’t make any money.”