Advisers choosing hedge-style stock-pickers face ‘beta’ challenge

A letter in the Greek alphabet is key to understanding the core risks facing the most popular alternative-investing category in mutual funds: beta, according to two analysts who spoke on an InvestmentNews webcast.
The analysts pointed to two risks in mutual funds that can bet on both rising and falling stocks. The first is that the funds have largely failed in their attempts to time the market, according to Jason Kephart, an alternative investment strategies analyst at Morningstar Inc. The second risk is that managers sometimes charge plump fees while closely tracking the market, according to Dick Pfister, chief executive of AlphaCore Capital.
Beta is a way to measure both.
The category of mutual funds called long-short equity is the biggest winner in a push by advisers to sell more hedge-fund style strategies. On average, the funds returned -1.31% last month as volatility struck U.S. markets. That headline number compared favorably with the -1.94% of the benchmark S&P 500. For the year, they’ve delivered 0.64% to the S&P’s 2.15%.
The numbers are not directly comparable because long-short funds typically choose to take on less risk than the market, a risk that’s often measured by the statistical calculation called beta.
One problem is that some funds in the category are tracking the broad market very closely, said Mr. Pfister, whose financial advisory firm is a big proponent of alternative strategies. He recommends investors “peel back the onion” and look at signals, such as beta, to examine whether fund managers are effective.
CLOSET EXPOSURE
“What you shouldn’t expect is, when you’re looking at a long-short equity mutual fund manager, their beta should not be in a tight range close to one,” Mr. Pfister said. A beta of one reflects a fund that responds very directly to market swings. “There’s a lot of closet, long-only exposure in that fund.”
Mr. Pfister showed a chart, dated June 19, of about two dozen funds that take long positions, buying some stocks while shorting others, betting their price will fall. Four of the funds displayed appeared to mostly register a beta of one, when compared with the trajectory of the benchmark Russell 3000.
Mr. Kephart said a major challenge among managers in the long-short space has been dialing up and down their exposure to market risk at the right time.
“We’ve found that, over time, the amount of managers who can get those calls right consistently is basically zero,” Mr. Kephart said. “The ones that have been more successful have stayed in a range-bound beta exposure and delivered excess returns through their stock-picking skills.”
Long-short equity strategies, long deployed in hedge funds, have been the largest beneficiary of a surge in hedge-style strategies migrating to mutual funds. There is at least $56 billion in long-short equity strategies, in the U.S., according to Morningstar. But the category has struggled with outflows since last year, as performance fell off in the MainStay Marketfield Fund (MFADX), once the top-selling fund of its kind.

Related Topics: Morningstar Inc., New York Life Insurance Co.