Morningstar to create new style box for liquid alt funds

It will help advisers and investors measure correlation and volatility of past returns

Oct 20, 2016 @ 1:12 pm

By Jeff Benjamin

Morningstar is moving financial advisers a step closer to cutting through the fog of alternative-strategy mutual funds by creating a fresh set of style boxes just for liquid alternative funds.

The new style boxes, which are still under construction, will use past performance to measure patterns of volatility and correlation to global equity markets.

While still far from the perfect solution for fully evaluating the fast-growing and increasingly complex universe of liquid alt funds, the effort is seen as a step in the right direction.

“I think it does a good job of taking the next step, and they had to do something because the style boxes for traditional funds didn't make sense for alternative funds,” said Dick Pfister, founder and chief executive of AlphaCore Capital.

“This is definitely not the end game, but it is one step closer to providing valuable information for analyzing alternative strategies,” he added. “I have historically been more critical of Morningstar, but in this case I'd say it's a move in the right direction.”

Morningstar acknowledges that the new style boxes will not completely solve the riddle of how to best utilize liquid alt strategies, but it will give financial advisers and investors a clearer picture of how alternative strategies have lived up to their promise, according to analyst Jason Kephart.

“The goal is to help people think about how alternatives would fit into a portfolio, and to help people build better portfolios using alternatives,” he said.

The alternatives style boxes, similar to the nine-box grid Morningstar uses for traditional strategies, will use past performance to divide funds based on correlation and volatility, two important components of alternative investing.

“If you want a pure diversifier, you'll want low or negative correlation, and if you're more concerned about lowering risk, you'll be more concerned with volatility,” Mr. Kephart said. “It's a useful tool to make it easier to determine a fund's diversification characteristics. It's a good starting point.”

Even through the extended bull market in equities has largely overshadowed the need for diversification into alternatives, the liquid alt space has continued to swell.

The number of liquid alt funds has increased by 184% to 484 funds since 2008, while total assets have grown by 378% to $178 billion.

The growth, however, has been accompanied by growing confusion and frustration over how to best evaluate and benchmark liquid alt funds.

Many funds are still benchmarking to either private hedge funds, stocks or cash, none of which is truly appropriate.

But by providing a measurement of correlation to global equities and volatility, Mr. Kephart said, investors and advisers can at least see whether various funds acted as portfolio diversifiers, which is the ultimate goal of an alternative strategy.

“It's important for advisers to know that there is a lot of dispersion in the returns of alternatives, and there's also a lot of dispersion in the correlation and volatility of funds within the same category, and you can't just look at returns when evaluating an alternative fund,” he said.

The backward-looking nature of the style boxes should always be taken into consideration, but advisers should be able to appreciate the starting point of the analysis, according to Todd Rosenbluth, director of mutual fund and ETF research at CFRA.

“The alternative fund universe is very crowded, and it's important for advisers to be able to differentiate between the risk and reward the funds have been achieving,” he said. “There needs to be apples-to-apples comparisons, and the more tools advisers have to compare similar-sounding strategies the better.”

Ed Butowsky, managing partner at Chapwood Capital Investment Management, said the new style boxes are far from the perfect solution, but progress, nonetheless.

“I like it, but they need to go much deeper to provide something valuable,” he said. “Because that category is growing, this is going to be helpful to a lot of advisers.”


What do you think?

View comments

Recommended for you

Sponsored financial news

Upcoming Event

Apr 30


Retirement Income Summit

Join InvestmentNews at the 12th annual Retirement Income Summit - the industry's premier retirement planning conference.Much has changed - and much remains to be learned. Attend and discuss how the future is full of opportunity for ... Learn more

Featured video


Why some retirement plan advisers think Fidelity is invading their turf

InvestmentNews editor Frederick P. Gabriel Jr. and reporter Greg Iacurci talk about this week's cover story that looks at whether Fidelity Investments is stepping on the toes of retirement plan advisers.

Latest news & opinion

SEC Chairman Jay Clayton outlines goals for a new fiduciary standard

Rule should provide clarity on role of adviser, enhanced investor protection and regulatory coordination.

Advisers bemoan LPL's technology platform change

Those in a private LinkedIn chat room were sounding off about fears the independent broker-dealer will require a move to ClientWorks before it is fully ready.

Speculation mounts on whether others will follow UBS' latest move to prevent brokers from leaving

UBS brokers must sign a 12-month non-solicit agreement if they want their 2017 bonuses.

Maryland jumps into fiduciary fray with legislation requiring brokers to act in best interests of clients

Legislation requires brokers to act in the best interests of clients.

8 apps advisers love for getting stuff done

Smartphone apps that advisers are using in 2018 to run their business more efficiently.


Hi! Glad you're here and we hope you like all the great work we do here at InvestmentNews. But what we do is expensive and is funded in part by our sponsors. So won't you show our sponsors a little love by whitelisting It'll help us continue to serve you.

Yes, show me how to whitelist

Ad blocker detected. Please whitelist us or give premium a try.


Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print