It has been at least five years since Dick Pfister can recall a six-month period that has been so favorable to alternative investment strategies.
Mr Pfister, founder and president of AlphaCore Capital, a firm that allocates between 15% and 30% of client assets to alternative investments, said the Jekyll-and-Hyde scenario of the last two quarters presented an ideal test for noncorrelated investments.
Viewing alternative investments as tools for managing volatility and balancing risk, Mr. Pfister points to the 1.34% fourth-quarter gain in the market-neutral strategy BlackRock EventDriven Equity Fund (BILPX) against the 13.5% drop in the S&P 500 Index.
And in the first quarter of 2019, when the S&P bounced back with a 13.6% gain, Mr. Pfister was perfectly happy with the 5.4% gain by the long-short equity strategy Balter Invenomic Fund (BIVIX).
"We look at some alternatives as diversifiers," he said. "But we will also look at other alternatives as ways to capture chunks of up markets."
The message that investors, advisers and allocators like Mr. Pfister understand is that the big picture perspective rarely looks good for alternative investments, which is why those who dwell on broad category averages often get stopped at the gate.
The Morningstar Inc. category for market-neutral mutual funds, for example, produced an average gain of just 12 basis points in the first quarter, while the nine categories representing U.S. equity funds gained between 11.3% and 18.4% over the same period.
Making the case for alternatives, which are generally designed to neutralize market beta and enhance alternative alpha, is never easy when market beta is robust in the form of a bullish stock market.
The influence of market beta is illustrated by the options-based alternative fund category, which gained 6.63% as the best-performing alternative fund category in the first quarter, according to Morningstar.
"With equity markets rallying, strategies with higher beta exposure to equities have done better," said Tayfun Icten, senior analyst at Morningstar. "But in 2018, options-based strategies struggled because of the higher beta exposure."
The options-based fund category had an average decline of 5.51% last year, which compares to the 4.38% decline in the S&P.
However, a look beneath the broad category averages shows where even a hot-and-cold strategy like options-based funds can bear fruit.
The performance of the funds in the category show 12-month returns ranging from a 9.94% decline to a 15.36% gain.
Over the first three months of the year, when the options-based category gained 6.63%, the return on individual funds ranged from an 80-basis-point decline to a 20.4% increase.
"It's about manager selection, it's not about category-level allocations," Mr. Icten said. "It's the same with hedge funds, where only the top 10% have anything special and the other 90% are just recycling."
He cites as an example of a fund that has been adding alpha the JPMorgan Hedged Equity Fund (JHEQX), which trounced the options-based category's 5.51% decline last year by losing just 71 basis points.
In the first quarter of this year, the fund posted a respectable 3.91% gain against a category average gain of 6.63%.
That is the reality of allocating to alternative investments. To benefit from the diversifying factors, investors and advisers must appreciate that losing less than the market can often mean gaining less than the market.
"There's always something to complain about when you have a diversified portfolio," said Hans-Christian Winkler, a financial planner at Claraphi Advisory Network, where client portfolios have between 20% and 30% allocated to alternatives.
"A diversified portfolio will never outperform the market, but in times like the last quarter of 2018, when we saw the market down 20% from the high, our portfolios with alternatives were down 5%," he added. "By using alternatives, you are spreading out your risk and making your investment portfolio a lot less bond-market- and stock-market-dependent."
Perhaps not surprisingly, over the 12-month period through February, options-based funds led all alternative fund categories with 24% asset growth excluding investment performance. The next-best category for asset growth, and the only other alternative category with positive organic asset growth over the period, was market-neutral funds at 11.5%.
The market-neutral category, which gained 15 basis points in the first quarter, declined by 26 basis points last year.
The 12-month performance for funds in the market neutral category ranged from a loss of 13.84% to a gain of 13.09%.
"Alternative categories have a wider dispersion of performance, much wider," Mr. Icten said. "If you misallocate to a particular alternative strategy you can seriously get hurt, which is why the most important things are the people and the process when it comes to alternative investments."
There are times when entire alternative-investment categories will be destroyed by their investment strategy, and while bear market funds that perennially bet against the stock market are an easy example, the current state of managed futures funds also illustrate how things can go wrong.
The category, which gained 1.08% in the first quarter and lost 5.78% last year, is at the mercy of a strategy that looks for medium- and long-term trends in equities, bonds, currencies and commodities.
"Most of them have been flipping back and forth and not showing enough trends to generate attractive returns, and a big part of it was the fixed-income markets," Mr. Icten said. "People expected bond yields to go up and that hasn't materialized. Yields went up, came back down, went up again, and came back down. The same thing happened in most currencies."
But as brutal as it has been for managed futures funds, it's worth noting that in the first quarter, the funds making up the category produced returns that ranged from a loss of 11.71% to a gain of 9.88%.
"The biggest thing is education, and the last two quarters have been a great tool for us to talk through with clients about the benefits of alternatives," said Jeffrey Nauta, principal and chief compliance officer at Henrickson Nauta Wealth Advisors, which has been allocating to alternatives for 20 years.
He said 80% of his clients are invested in alternative strategies, which make up between 20% and 40% of their portfolios.
"We explain to clients the more you have in alternatives the less your performance is going to look like the markets, good or bad," Mr. Nauta said. "To us, the past two quarters were a great teachable moment for clients. It tells the story that over time we're going to have good and bad quarters, and the last quarter shows that there are times when alternatives will lag."