An extreme tale of two liquid alt funds in the same category

When fund managers can go anywhere, sometimes they do

Oct 9, 2015 @ 11:13 am

By Jeff Benjamin

The late-summer bout of stock market volatility has shed fresh light on alternative-strategy mutual funds and, once again, has reminded investors and financial advisers that these funds are very different from traditional long-only funds.

Seasoned investors in the liquid alternatives space likely are familiar with the kind of extreme performance dispersion that is often seen across various fund categories, but this year the multialternative fund category is serving up a perfect reminder of why averages mean very little when it comes to liquid alts.

On one end of the eclectic collection of funds in the category is the Catalyst Macro Strategy Fund (MCXAX) touting a 31.81% gain since the start of the year.

On the other end, there is the Morgan Creek Tactical Allocation Fund (MAGTX) nearly 45 percentage points behind the Catalyst Macro fund with a year-to-date decline of 12.76%.

To further muddy the analysis, consider that the multialternative category average, as tracked by Morningstar Inc., is down 1.59% over the same period.

Some alternative investments specialists lay blame on the loosely-defined nature of the catch-all multialternative category, pointing out that the Catalyst fund is an outlier and that the Morgan Creek fund is primarily a long-only strategy.

A tale of two funds
Source: Morningstar
Note: Performance is through Oct. 8


“It exposes several things, including that the categories are poorly defined,” said Bob Rice, chief investment strategist at Tangent Capital.

“To treat those two funds as the same thing is fundamentally wrong, but even if you tossed out the Catalyst fund as an outlier, a multialternative fund shouldn't be down 12%,” he added. “They're being paid to make a little money and not take big risks.”

If the Catalyst fund is removed from the multialternative category, the top-performer this year is up 7%, narrowing the top-to-bottom performance spread to about 20 percentage points.

But Morningstar analyst Jason Kephart pointed out that even with the Catalyst fund included, the gap between the performance of the top 20% of funds and the bottom 20% is only four percentage points.

“It's still a big spread, but not nearly as much as you get when highlighting the two extreme examples,” he said.

But as Mr. Rice is fond of saying, “Averages mean very little as a guide to how alternative assets perform, because you don't take an average date to the prom, you take your actual date.”

In other words, Morgan Creek investors probably don't care that the category average is only down 1.59% so far this year.

Dick Pfister, president and chief executive of AlphaCore Capital, also believes better categorization of liquid alt funds would be helpful for investors, but he understands why the Morgan Creek and Catalyst funds are currently lumped together.

“They both are basically trading the same four sectors, and I'm sure that's what Morningstar uses as a litmus test,” he said. “But it's not easy to just whip out a new category.”

Mr. Kephart attributed part of the extreme performance dispersion to the fact that many liquid alt fund mandates allow portfolio managers “much freedom.”

“This highlights the manager risk,” he added.


While the Morgan Creek and Catalyst funds might appear to represent polar opposites lost in the same multialternative fund category, they do share a few similarities that make for an interesting study.

Neither fund has a three-year track record, both funds are still relatively small, and they both represent examples of the kinds of products that have flooded into the liquid alts space over the past few years.

The Morgan Creek fund, which manages less than $30 million, was launched in August 2013 by Mark Yusko, founder, chief executive and chief investment officer of Morgan Creek Capital Management.

Mr. Yusko declined to comment.

Todd Rosenbluth, director of mutual fund and ETF research at S&P Capital IQ, described the Morgan Creek fund as “another one of these go-anywhere strategies intended to benefit from diversification efforts.”

“It looks like the fund tries to offset risk with fixed income,” he added. “But you're paying a lot of money for this fund, and that kind of performance should be cause for concern.”

The fund has a 2% expense ratio and a 559% annual turnover rate, according to Morningstar.

The Catalyst fund, which manages more than $100 million, was launched in March 2014 and is managed by David Miller, chief investment officer of Catalyst Funds.

The fund also has an above average expense ratio of 1.95%, but has an annual turnover rate of 60%.

Mr. Miller describes the foundation of the strategy as taking advantage of volatile and mean-reverting markets by shorting pairs of leveraged exchange-traded funds.

For example, he will short both the VelocityShares 3X Inverse Natural Gas (DGAZ) and the VelocityShares 3X Long Natural Gas (UGAZ), hedging out the market risk but taking advantage of the “consistently awful performance of triple-levered ETFs.”

The strategy has worked so well primarily because he is applying longer-term shorts on ETFs that are designed as short-term trading vehicles.

“The levered ETFs are so flawed in their construction because they are so over-levered,” Mr. Miller said. “You don't have to bet on the direction of the underlying asset because the pairs will never both go up at the same time.”

The strategy has worked so well that it helped boost the fund's assets by 1,900% from less than $5 million in June.

But Mr. Miller concedes the strategy is “not a one-way street,” as was illustrated over the past 30 days when the fund's 5.61% drop made it the worst-performer in the multialternative category. Over that same period, Mr. Yusko's Morgan Creek fund declined by 1.18% while the category average lost 0.25%.

“The Catalyst fund was right on a lot of those big levered bets,” Mr. Kephart said. “But just like they can get big returns, there are potential for big losses if they are wrong.”


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