Open-end mutual funds that invest in alternative strategies have had a good year. According to Morningstar, investors have poured more than $28 billion into this category through Aug. 31, the highest growth level of all fund categories tracked by the research firm.
Alternative funds are attracting attention from regulators and the media, not all of it favorable. For example, regulators have been critical of some of their fees, suitability requirements and lack of liquidity.
Plus, many alternative products’ recent returns have been trailing the S&P 500 Index, though some investors and experts use such products not to keep up with the major indexes but to earn “reasonable returns” along with diversification.
Andrew Clark, manager of alternative-investment research for Lipper, has taken an in-depth look at the risk-return characteristics and diversification benefits of some products.
Clark put together a hypothetical, broadly diversified portfolio consisting of six long-only asset classes: bonds (U.S. and international); global equities; commodities and real estate (U.S. and international). He used a total of six mutual funds and ETFs to track these markets:
- iShares Dow Jones U.S. Real Estate ETF (IYR)
- Fidelity International Real Estate (FIREX)
- Barclay’s Aggregate Bond ETF (AGG)
- GSCI Commodity ETF (GSG)
- Vanguard Global Equity (VHGEX)
- T. Rowe Price International Bond (RPIBX)
He then measured a set of risk-return measures for these funds from March 2007 through September 2012: return, volatility, downside deviation, Sharpe and Sortino ratios, skewness and excess kurtosis (or peakedness in distribution).
Using Lipper’s alternative investment categories’ averages for each strategy’s proxy, he calculated the same risk-return statistics for each alternative strategy:
- Long/short equity
- Long/short bond
- Global macro
- Managed futures
Clark found that several of alternatives strategies (when used as stand-alone investments) had greater returns, less extreme risk and often better risk-adjusted returns.
The expert also created portfolios that combined long positions with several arbitrage strategies: arbitrage, global macro, long/short equity and market-neutral. He tested portfolio allocation to the alternatives of 5%, 15% and 30%.