New Options for Investors Seeking All-in-One Alternatives Exposure.
2012 was a big year for multialternative mutual funds. The category saw 17 new offerings last year, the second-most launches in the alternative space. Though the rate of inflows hasn’t accelerated as quickly as the product launches, flows have been strong—more than $4 billion, each year, for the last two years in a row. And assets in the category reached $17.9 billion last year, representing an increase of 37.2% from 2011. Even more surprising, however, is the amount of assets raised in the newly launched funds. Six of the 17 new funds have $100 million in assets, and one raised more than $700 million. By comparison, the long/short equity category saw 15 new offerings last year, but only two have raised more than $100 million.
It’s clear that many investors are becoming more interested in alternatives exposure, and these multialternative funds are intended to serve as a one-stop shop solution, saving investors the hassle of deciding which alternative strategies and managers to allocate to, and how much. But before investors dive in, it’s important to know that there are various flavors of multialternative funds, and some may suit one’s needs better than others.
Replication or the Real Deal?
Some of the first multialternative mutual funds were hedge fund replicators. At heart of the idea was that hedge funds, on average, don’t generate alpha, but instead offer investors a favorable mix of beta (market) exposures (such as emerging markets or credit). If that were true, the thinking was that a prudent investor could allocate to a hedge-fund replicator, which invests in those “betas” via exchange traded-funds or futures contracts, without the “2 and 20” fee structure (where investors pay a 2% management fee and give up 20% of any gains to the firm running the hedge fund) and onerous liquidity terms. In practice, however, replicators haven’t performed as expected. Goldman Sachs Absolute Return Tracker GARTX and Natixis ASG Global Alternatives GAFAX, for example, receive Morningstar Ratings of 2 stars, reflecting their subpar risk-adjusted performance.
As mutual funds of actual hedge fund managers are encroaching into the multialternative space, the idea of hedge fund replication is losing its luster. These two funds lost $386.8 and $283.8 million in 2012, more than any other funds in the category. Conversely, bronze-rated IQ Alpha Hedge Strategy IQHIX, a more actively managed replication strategy, managed to entice a few investors. This fund bested its replication peers in 2012, gaining 4.75%.
The funds doing the most active, hedge fund-like strategies themselves, such as JHancock2 Global Absolute Return Strategies JHAAX, Arden Alternative Strategies Fund ARDNX, and AQR Multi-Strategy Alternative Fund ASAIX, received the bulk of the multialternatives category’s inflows ($1.5 billion, $729.1 million, and $524 million, respectively) in 2012. The John Hancock and AQR offerings are internally managed multi-strategy funds, while the Arden fund is a fund of external hedge fund managers. Both strategies fulfill their own need.
Build or Buy?
When selecting an actively managed multi-alternative fund, investors must understand if the offering is a combination of internally managed strategies, or a combination of external subadvisors.
There are pros and cons to each model. Internally managed multi-strategy funds, for example, have the ability to control risk and all positions in house—netting out overlapping positions between strategies, for example--all at a reasonable cost compared to its peers. The downside is that they may combine strategies that either aren’t core to the fund shop’s expertise. In addition, some internally-managed funds are not diversified enough to serve as a “one-stop shop” alternatives solution.
AQR Multi-Strategy Alternative Fund overcomes both of these obstacles. For 1.99% (on the institutional shares) management offers a wide range of in-house strategies, including arbitrage, managed futures, and long-short equity, which it has been managing successfully in private products since the 1990’s. The fund’s correlation to the S&P 500 and the Barclays U.S. Aggregate Bond Index is low, 0.23 and -0.04 respectively (using weekly data since inception through January 2013). Theoretically, low correlations, coupled with positive performance, can increase investor risk-adjusted returns. Its performance (0.02 since inception through Feb. 4, 2013) could be better, though.
JHancock2 Global Absolute Return Strategy JHAAX has had better luck than the AQR offering. Although this internally-managed multialternative mutual fund has only been around for a year, the same strategy run by its subadvisor (Standard Life, a large UK based pension firm) has ranked in the top quartile of the Europe open-end alternative- multistrategy category each calendar year since the fund’s 2008 inception. Management invests across a wide variety of long-short equity, fixed income, and currency strategies, seeking a return of LIBOR plus 3.5%, above its fees of 1.95%.
A League of Their Own
Externally managed strategies have the ability to find the best in breed managers for any particular strategy, and can fire a manager that is underperforming. The major drawback to these types of funds is their high fees. The category’s average prospectus net expense ratio is 2.1%, yet the subadvised funds’ fees are all more expensive, with the most expensive being Hatteras Alpha Hedged Strategies ALPHX, at 3.99%. Typically, these funds' subadvisors are hedge fund managers, who are used to the “2 and 20” fee structure, so it is hard for a middleman to structure a quality fund of hedge fund managers at a reasonable price point. Arden Asset Management ARDNX has succeeded, however. This fund has signed on headliners such as JANA Partners and York Capital for a 2.3% expense ratio.
Shopping for a One-stop Shop
The beauty of a multialternative fund is that investors can fill their entire alternatives allocation with just one fund, as opposed to selecting a basket of alternative funds and figuring out how to weight them. But filling that sleeve with just one fund means choosing the right fund becomes even more important. Whereas there aren’t a lot of multialternative funds with solid, long term track records, better and better options are popping up every day. Plus, as assets continue to grow, investors should expect fees to head lower.