Alternative-investment strategies can benefit client portfolios. But some managers’ high minimums restrict access for smaller investors.
That restriction has led to the emergence of mutual funds that invest with alternative-strategy managers — with lower account minimums.
A logical progression for fund providers was to create multi-manager funds.
These funds increase diversification by allocating assets among managers and strategies. Investors apparently find this approach attractive.
According to Morningstar data, 17 multi-alternative funds launched in 2012. Plus, the category’s growth has been strong in early 2013: Assets in multi-alternative open-end funds grew from $17.97 billion in January to $20.11 billion by April 30, the Chicago-based research group says.
Jeremy DeGroot (left), chief investment officer of Litman Gregory Asset Management in Orinda, Calif. (near San Francisco) and manager of the Litman Gregory Masters Alternative Strategies Fund recently shared his insights on alternatives with ThinkAdvisor.
The Litman Gregory fund (MASFX, MASNX) has $587 million in assets allocated across four mangers and strategies: Loomis Sayles (strategic-alpha fixed income); Water Island Capital (arbitrage strategy); DoubleLine (opportunistic income) and FPA (contrarian opportunity).
Why did you selecting these managers and strategies?
The selection of managers and strategies was driven by what we are trying to accomplish with this fund.
First, obviously we wanted highly skilled managers who we strongly believed have the ability to add significant alpha over time and generate strong risk-adjusted returns.
And we wanted strategies that would be complementary and provide diversity to the overall fund portfolio.
Finally, fees were important since our objective has been to deliver a quality fund at a reasonable fee level.
Our assessment of the managers and strategies was based on our qualitative due diligence and our quantitative analysis of their track records.
Important to us was the willingness to be opportunistic from a tactical standpoint– specifically a willingness to increase or reduce risk based on their assessment of risk/reward trade-offs.
But we also wanted to create a fund that is not highly correlated with stocks and bonds, and that we believe would be relatively low risk compared to stocks and also on an absolute basis in terms of downside performance. Both of these objectives are very important.
We didn’t want a low-risk fund that wouldn’t have the potential to generate much return or, conversely, a fund that would turn out to be too volatile.
With respect to risk management we sought to hire managers who met two criteria: First, they each would have a different investment approach and/or investment universe that collectively would result in a portfolio that we believed would not be highly correlated to the stock market and the bond market and would have a low equity beta.
Second, we were only interested in managers who we believed would run a low risk portfolio by virtue of their investment approach or investment universe, and/or because of their risk mindset.
And at the overall fund portfolio level, we wanted a mix of managers and strategies that we did not believe would be highly correlated with each other.
How has the fund performed to date?
The fund’s performance since inception has been strong on an absolute and risk-adjusted basis and also relative to its Morningstar Multialternatives peer group category. We have also been pleased with the performance relative to the risk and return objectives we set at the time the fund was launched 20 months ago.
Through May 31, the average annual return since inception has been 10.6%. The standard deviation has been only 3.3%, even lower than we have targeted (in the 4% to 8% range).
This compares to 11.4% for the S&P 500 standard deviation and 2.6% for the Barclays Aggregate Bond Index.
The fund’s annualized Sharpe Ratio through March 31 is 3.1 compared to 1.0 for the bond index and 2.2 for the stock index.
Have those returns been in line with your expectations?
So far we’d say the fund has met or exceeded our expectations.
The fund’s annual volatility has actually been below our expected range of 4% to 8% and close to the bond market’s.
We’ve also been generally pleased with the performance of the fund during the several short stock-market down drafts we’ve experienced since it was launched in fall of 2011.
For example, the fund’s worst drawdown during that 20-month period is only 1.8% compared to 9.6% for the S&P 500. Its equity beta has been very low at 0.1.
The fund’s 10.6% annual return has been somewhat higher than we would expect, especially given the fund’s very low equity exposure during what has been a strong return environment for stocks.
We’ve been pleased that it has significantly out-returned its Morningstar Multialternative peer group by 10.6% compared to 4.0%, while exhibiting almost identical volatility.
For direct insights on the role of ETFs in client portfolios from multiple experts—including Rick Ferri, Ron Delegge, Skip Schweiss and more—we invite you to register for AdvisorOne’s premiere advisorcentric Virtual ETF Summit, which starts July 23 (and get multiple hours of CFP Board CE).