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An Early Read on the 2014 Morningstar Alternatives Fund Manager of the Year

We are developing a pool of potential candidates.

Josh Charlson, 11/18/2014

As part of the early handicapping for Morningstar's Fund Manager of the Year awards, we've run screens across the various categories (awards are given for domestic-stock, international-stock, fixed-income, allocation, and alternatives managers) to identify potential front-runners. Before turning to the alternatives group, I want to caution that these results are quite provisional; with two months remaining (when we ran the data) in what has been a very volatile year, it's quite possible that additional candidates could emerge or that someone on the current long list could experience a hard stumble.

Some additional caveats are in order when it comes to alternatives fund managers. For one thing, the list of Morningstar Medalists in alternatives categories (a baseline criterion to be considered for the FMOY award) is small, numbering only 24, which leaves us a limited initial candidate pool. Moreover, when considering the performance of alts managers, it's important to consider the role typically intended for alternatives within investor portfolios. Most alts funds are hedged relative to standard stock and bond indexes, and many advisors and investors view them as diversifying components of a portfolio. Thus, a simple screen based on funds' year-to-date returns and relative category ranking captures only part of the picture. We've extended our filters to examine Sharpe ratio, beta, and correlation.

Finally, it bears mentioning that while we typically look for managers who not only have had a great calendar year but a stellar long-term track record, when it comes to alternatives long-term may mean only five years, and most alternatives funds have emerged in only the past couple of years. We still lean toward managers with impressive histories--whether at their current fund or running similar strategies in other structures--but it's rare to find an alternatives fund with 10 years of history under a single manager.

Caveats aside, the burst of new alternatives vehicles over the past few years means more options for investors, and more managers whose strategies are worthy of investors' attention and dollars. The managers mentioned below have all delivered so far in 2014 on the objectives investors seek in alternative investments, and they may be in the running when it comes time to make the official nominations.

Repeat Customers 
Two of the funds on the list have been nominated before, and one was in fact our inaugural alternatives winner in 2012. It isn't surprising to find some repeat names on the list. Managers who have proven, repeatable investment processes are likely to hit the radar in multiple years, as happens frequently in the other asset classes. TFS Market Neutral TFSMX, the 2012 award winner, uses a heavily quantitative process within a market-neutral structure; the fund has generated fairly consistent alpha by identifying 10 different trading models and continuously updating its models over time. The fund's small-cap bias has been a detractor in 2014 (as the Russell 2000 is lagging the S&P 500 by 9.1% this year through October), but its 1.75% return through Nov. 7, 2014, is 120 basis points ahead of the category average. The six portfolio managers, including firm co-founders Rich and Kevin Gates and Larry Eiben, invest significantly in the fund.

Robeco Boston Partners Long/Short Research BPIRX was a nominee for Alternatives Manager of the Year in 2013, and it's extended its impressive track record thus far in 2014. This analyst-run fund allots separate sleeves to nine different analysts, overseen by CEO Joseph Feeley and research director Eric Connerly. The fund has shown notable success in its shorting process relative to peers, and its 5% return through Nov. 7 ranks in the category's top quartile, with shorts once again providing positive alpha. Over the trailing three years through the end of October, the fund's Sharpe ratio of around 2.0 nearly doubles the category's risk-adjusted return.

Robeco Boston Partners has a long history running alternative strategies, and its flagship alternatives fund is actually Long/Short Equity BPLEX, which launched in 1998. This year the fund makes it into the early running for consideration on the strength of its 6.6% year-to-date return, among the top 15% in the long-short equity category. The results are more impressive when considering the fund's relatively low beta of 0.26, amounting to alpha of around 7%. Lead manager Bob Jones (one of the founders of Boston Partners, which was acquired by Robeco in 2002) has historically exhibited a small-cap value bias, though lately the fund has taken more of an all-cap approach. On the short-side, Jones targets overhyped "concept" stocks with unstable business models. Shorting smaller-cap names can be difficult and expensive, but management has had considerable overall success here: After losing 21% in 2008 (more than the average peer), it zoomed an astounding 81% in 2009 thanks to various small-cap long wagers. Investors should expect more volatility here than with its sibling, and it also features a significantly higher price tag.

Josh Charlson is a senior fund analyst with Morningstar.

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