“I’m skeptical of the faddishness of alternative investments. Wall Street is always ready to feed the ducks, and the ducks are quacking.”
Jeremy DeGroot, chief investment officer of Litman Gregory, obviously doesn’t think much of the packaged alternative products now being offered by manufactures and distributors. The space is much too complicated to simply allocate a portion of the portfolio to any old noncorrelated asset class and expect good results. It’s one reason he constantly refers to the research his team at Litman Gregory is able to perform.
“It’s heavily qualitative and deep manager due diligence,” GeGroot says. “They have to have the discipline to consistently beat the index, which we all know is hard to do.”
Since 2008, equity returns have been muted, and fixed income served as the ballast to protect on the downside, he argues. Today, there is no cushion of yield on the downside that was once available in the past.
“For this reason, alternatives make sense,” he continues. “The problem is that few managers have a solid track record because alternative asset classes are so new. Any back test has to be taken with a grain of salt, because you never see the nine back tests that didn’t work before they got to the tenth. So there’s a scarcity of managers successfully running these strategies.”
Because of the untested managers and the high expense ratios they often charge in the mutual fund wrapper, Litman Gregory managers decided to do it themselves.
“We’re not picking stocks; we’re picking managers through our qualitative process. We emphasize lower risk, lower correlation and therefore lower volatility; something with a return of LIBOR plus 4 percent to 8 percent.”
Enter the multimanager, multidiscipline, subadvised Master Funds. DeGroot and his team start with demonstrated risk-averse managers. The due diligence requires a lot of the managers time.
“We do our homework, but once we invest, we are truly long-term shareholders,” DeGroot adds. “We understand periods of underperformance. We inoculate ourselves by heavy research into why something is underperforming, when it will come back and how it fits into the portfolio.”
The research-intensive process has paid off. Managers they’re partnered with include DoubleLine’s Jeff Gundlach, FPA Crescent Fund’s Steve Romick, Loomis Sayles’ Matt Eagan and water Island Capital’s John Orrico.
“You can’t simply by an S&P 500 index for alternatives,” DeGroot concluded. “You’re betting on the manager to get alpha. Saying ‘here’s 30 percent to generic alternative investments; I’m all set’ won’t work.”