If nothing else, the carnage of the past few years has served as a stark reminder of the value of portfolio diversification.
In addition to stocks, bonds, cash and real estate, many financial advisers try to add alternative investments to round out the asset mix, typically allocating 10% to 25% to less correlated strategies. Alternatives can be acquired directly, of course, but advisers should also consider the alternative strategies found in the form of mutual funds designed to zig when the stock market zags.
Morningstar Inc. counts nearly 200 mutual funds that fit into one of five broad alternative categories, including long-short equity, currencies, precious metals, bear market and commodities. Some deeper digging can uncover more than twice that number of registered investment products that provide alternative exposure.
By including exchange-traded notes, exchange-traded funds, closed-end funds and mutual funds, Rick Lake, co-chairman of Lake Partners Inc., has compiled a universe of 500 registered products that fit the definition of an alternative investment. He argues that a registered fund must use, to a significant degree, short selling, hedging instruments such as options or an alternative strategy such as private placement, commodities or leverage to be considered alternative-class.
Since, of course, not everyone has the will or wherewithal to invest in a hedge fund or private-equity vehicle, the registered universe offers ample opportunity to hedge without the use of hedge funds. And in any market environment, but especially this market, Mr. Lake said, “long only is wrong only.”
Mr. Lake, who oversees $3.5 billion worth of alternative-investment portfolios, mostly for institutions, uses liquid registered products to apply the same type of alternative strategy in the management of a mutual fund that invests in other alternative and hedgelike mutual funds.
Mr. Lake, who manages the Aston/Lake Partners Lasso Alternatives Fund (ALSOX), launched in April 2009, keeps the fund at between 20% and 50% net long.
For long-short credit and strategic fixed income, for example, he uses the Eaton Vance Global Macro Absolute Return Fund (EAGMX). To help fill out the long-short equity category, Mr. Lake uses the Weitz Partners III Opportunity Fund (WPOPX). And to gain exposure to the arbitrage strategy, he uses the Merger Fund (MERFX).
There are plenty of funds that employ hedging and other alternative strategies, but there are also funds such as Alpha Hedged Strategies (ALPHX) and Beta Hedged Strategies (BETAX) that are actually subadvised by hedge fund managers. The funds, both managed by Lee Schultheis of Hatteras Funds, a $1.8 billion alternative-investments platform, contract with hedge funds to manage slices of the mutual fund portfolios.
“These kinds of funds are providing financial advisers with access to liquid alternative investments,” said Hatteras chief executive Brian Jacobs. “We know that advisers want alternatives for their clients, but the challenge for most of them is figuring out a way to do it.”
The mutual fund industry has been trying to horn its way into the alternatives area since at least 1997, when a rule restricting the use of short selling inside registered products was abolished. There have been some hits and plenty of misses, including a raft of expensive and sluggish market-neutral strategies that got lost amid the technology bubble of the late 1990s.
One issue that initially deters many financial advisers from considering these types of alternative mutual funds is the higher fees. The total expense ratio of Mr. Lake's mutual fund, for example, hovers around 2.7%, depending on the expenses of the underlying funds, which range between 1.3% and 1.5%.
But as most proponents of alternative mutual funds point out, a 2.7% expense is peanuts compared with the cost of a direct investment in a hedge fund or fund of hedge funds, which can charge a 1% or 2% management fee in addition to a performance fee that could be as high as 20%.
And as the registered fund industry continues to become a viable source of alternative strategies, the focus will be less about the package (hedge fund, mutual fund, ETF, etc.), and more about the management, strategy and history.
“The case for direct investment in a hedge fund versus a registered product like a mutual fund is really about looking under the hood to consider the manager and the track record,” said Jon Sundt, president and chief executive of Altegris Investments Inc., which has $2.5 billion on a platform that provides advisers with access to alternative strategies. “There's no good reason why a mutual fund couldn't go toe-to-toe with a hedge fund.”
Mr. Sundt's firm has filed the Altegris Managed Futures Strategy Fund with the Securities and Exchange Commission, with a launch slated during the third week of July. Because the mutual fund is in registration, he declined to discuss it.
Questions, observations, stock tips? E-mail Jeff Benjamin at [email protected].
