The fact that inflows into alternatives funds continue to be heavy even while they are underperforming the broad equity market suggests to market analysts and asset managers that investors are recognizing and embracing the defensive characteristics of alternative strategies.
The bear market mutual fund category, as tracked by Morningstar Inc., for example, saw nearly $350 million in net inflows this year through June despite posting a category average decline of 11.6% from the start of the year.
60/40 ISN'T WORKING
“Every single person I know is going to their adviser and saying the standard 60/40 allocation to stocks and bonds isn't working anymore,” said Michael Gaviser, senior managing director of alternatives at AllianceBernstein LP.
“Investors want absolute return and risk control,” he added. “Clients aren't saying they want a managed-futures fund, per se; they are saying they want something that will help them to do better than what they did in the past and something that doesn't go down with everything else.”
DEFENSIVE PLAYS
The fund flow data, when coupled with performance numbers, clearly indicate that there is a lot of defense being played, which also can be interpreted as a lot less performance chasing.
The seven broad equity and fixed-income fund categories defined by Morningstar as being alternative strategies total just over $77 billion but saw total net inflows of nearly $6 billion this year and almost $15 billion last year.
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MULTIALTERNATIVES
The best-performing alternatives category so far this year, multialternative, which is a souped-up, go-anywhere, balanced fund strategy, has gained an average of 1.1% from the start of the year and seen $1.3 billion in net inflows.
On a trailing-one-year basis, the multialternative category is down 2.2%. On a trailing-three-year basis, it is up 4.7%, and on a trailing-five-year basis, -1.2%.
The S&P 500, by comparison, has trailing-one- and three-year returns of 5.3% and 17%, respectively. The index's trailing-five-year average is -0.5%.
“Investors are certainly looking for lower correlation, and that's why alternatives have almost become a fourth asset class [in addition to stocks, bonds and cash] as an added level of diversification,” said Tim Clift, chief investment strategist at Envestnet Inc., which has $25 billion under management.
FOCUS ON BENEFITS
While the performance of some nontraditional categories might have recently lagged the broader equity markets, the focus should be on the benefits, according to Ryan Tagal, Envestnet's vice president of product management.
A study by Envestnet last year identified approximately 1,000 mutual funds that apply such alternative strategies as going long and short, leveraging and/or using derivatives.
One of the findings was that the alternative strategies had a beta range, or correlation to the broad equity market, of between -0.7 and 0.7, with 1 representing full correlation. The least correlated strategies were bear market and managed futures in a range from -0.7 to 0.2.
FUNDAMENTAL SHIFT
“We're seeing a fundamental shift in the way advisers are thinking about alternatives, which is due to more product availability and the current market environment,” Mr. Tagal said. “But investors and advisers are also very concerned that the equity markets of 2008 could happen again.”
Managed futures, the second-worst-performing alternatives category, after bear market funds, also represent a breakaway from traditional investing patterns, as the category average is down 2% so far this year after declining 7% last year.
The category is most likely still riding a wave of popularity following its solid 8.3% average gain in 2008, when the S&P 500 fell by 37%.
So far this year, managed-futures mutual funds have had nearly $700 million in net inflows, following $3.6 billion in net inflows in 2011.
But 2008 performance notwithstanding, the managed-futures category has seen a one-year average decline of 7.6%, a three-year average decline of 2.5% and a five-year average decline of 2.6%.
LONG/SHORT
In terms of net flows, long/short equity has become the most popular category, representing $2.3 billion in net inflows this year and $1.2 billion last year.
The category average is up less than 1% this year and declined by 2.8% last year.
On a trailing basis, long/short equity is down 2.6% over the past year, up 6% over the past three years and down 1.3% over the past five years.
One of the areas that has been gaining appeal in relation to the low-interest-rate environment is long/short fixed income.
The nine funds that Morningstar identifies as long/short fixed income, as part of the larger nontraditional-bond category, combined for an average 2.6% gain this year and an average 2.3% decline last year.
The nine funds, which represent less than $1 billion in total assets, saw $288 million in net inflows this year and $235 million last year.
The larger nontraditional-bond category has trailing-one-, three- and five-year returns of 2%, 6.1% and 3.7%, respectively.
Real estate, which doesn't fit everyone's definition of an alternative strategy, is one of the few categories that have rewarded investors this year.
According to Morningstar, the global real estate category had gained 15.4% through July 25, after declining 10% last year.
The $26 billion category has had $1.7 billion in net inflows this year, after net inflows of $2.1 billion last year.
“Without question, the real estate space is a good diversifier,” said Wilson Magee, director of global real estate investment trusts for Franklin Templeton Real Asset Advisors.
“The credit crisis tended to punish real estate stocks in a somewhat unwarranted way because it really was about credit concerns that failed to materialize,” he added. “I think investors were underallocating to real estate after the crisis, because the fundamentals of these businesses did not deteriorate.”
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