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Our Nominees for Alternatives Fund Manager of the Year

These nominees are topnotch. 

Josh Charney, 01/10/2014

Last year's market rally defied gravity. Investors, looking to diversify, have been on the prowl for strategies that offer lower correlation to traditional asset classes, like stocks and bonds. It's not surprising, then, that investors are turning to alternative mutual funds in droves. The group, which encompasses strategies such as long-short equity, market neutral, and managed futures, is considered "off the style grid." True, many of these funds hold plain-vanilla assets, but managers typically employ complex techniques, such as shorting, that alter the fund's DNA. In 2013, through November, investors poured $88.6 billion into alternative strategies; assets increased an astounding 51.4%.[1] Although there are now 431 alternative mutual funds in Morningstar's alternative categories, total assets still constitute less than 3% of the entire mutual fund universe. Alternative strategies, however, don't offer the promise of gangbuster returns; instead, investors should expect a smoother ride with the possibility of better risk-adjusted returns. Morningstar's 2013 alternative nominees delivered exactly that.

This year, our nominees provided a mix of superior risk-adjusted and absolute returns versus their peer groups. Funds within the same category, for instance, offer varying degrees of risk.  Also paramount to the nominating process were strategy and asset-class characteristics. Virtually any long-biased fund that touched equities did well in 2013, for example. Conversely, managed-futures funds, which use momentum-based strategies, largely floundered last year. Therefore, peer group analysis was extremely important to avoid punishing (or rewarding) unlucky (or lucky) management teams. Overall, the nominations shared characteristics that are core to selecting any alternative mutual funds.

The three nominees for Alternatives Fund Manager of the Year each delivered topnotch performance in 2013. The funds boast solid longer-term track records, too, and they're run by the same proven management teams that compiled those records. The funds also rate highly on Morningstar's five pillars (People, Process, Performance, Parent, and Price) and are thus each medalists (Bronze, Silver, or Gold)--Morningstar believes these funds will outperform their peers on a risk-adjusted basis over a full market cycle.

Team,  Robeco Boston Partners Long/Short Research BPIRX
2013 Return: 17.8%
Morningstar Category Rank (Percentile): 35
 
Robeco Investment Management (formerly Boston Partners) is a small subsidiary of Netherlands-based Robeco Groep N.V. The U.S. subsidiary primarily focuses on small- and micro-cap investing but also has a deep-rooted history in alternatives. It boasts a 5-star Robeco Boston Partners Long/Short Equity BPLSX that dates to 1998 and shares a process similar to the nominated fund's. That fund carries a Bronze rating. Further bolstering its alternative street cred, the Robeco Boston Partners Long/Short Research fund has been run internally since April 2002. (The internal fund's performance can be found in the prospectus.) Although its track record should be discounted because of the internal fund's small size, its performance still stands out. In 2008, for instance, the fund lost 8.4% versus a 15.4% decline for the category. In 2009, the fund zipped past the category's 10.5% return, gaining 18.4%. Post-launch, the fund has continued to excite, beating the category on an absolute return basis every year.

Key to management's success has been a laserlike focus on three core areas: valuations, business fundamentals, and business momentum. Each of the fund's nine analysts controls a sleeve of the portfolio--Joseph Feeney and Eric Connerly oversee the research process--and rank stocks based on the three factors. Because the team is so large, the fund has the resources to spread its bets across 400 positions. That diversification is essential for its "concept stock" short-selling strategy, because volatile short positions can rally, leading to losses. Analysts look for companies that have deteriorating business momentum, in terms of factors such as revenue growth, and are overhyped relative to valuations. Most recently, the fund held Netflix NFLX short because the company is on the hook for a growing amount of content-related costs. Although that trade didn't pan out this year, the diversified basket of shorts helps to soften the blow of a single position.  

In 2013, the fund beat the long-short category by 3.2%. In terms of risk-adjusted returns, the fund's Sharpe ratio handsomely beat the category (3.4 verses 2.9 for the category). Since inception, the fund has earned a 4-star rating and offered up an extremely attractive Sharpe ratio (1.5 compared with 0.9 for the category).

Team, AQR Managed Futures Strategy AQMIX 
2013 Return: 9.4%
Morningstar Category Rank (Percentile): 6

Lately, managed-futures products have been a tough sell. Acclaimed for resilient performance in 2008 (the category gained 8.3% that year), the group has subsequently floundered. But following 2008, the category has fallen an annualized 2.9%, through 2013. Managed futures are generally momentum-seeking trading strategies that profit from short- and long-term trends in a variety of asset classes—equities, fixed income, currencies, and commodities. There is plenty of academic research to support the validity of momentum and market trends as investing tactics. But perhaps even more important, momentum can act as a hedge during trending down markets, like 2008. Problematically, however, the strategies don't always work, and too many managed-futures funds offer far too narrow a focus, such as exposure to only one or two asset classes.

One of the keys to AQR Managed Futures Strategy's success is its broad diversification across trends and asset classes. The fund employs a simple but effective approach and relies on three trend signals: short-term, long-term, and overextended. The short-term trend signal looks at one- to three-month prices, while the long-term signal looks at prices relative to the last year—buying the contracts when prices are near the top of the range and shorting when prices reach the bottom. Finally, the overextended model can help soften the blow if a risky trade moves against the fund. Management understands that the overextended signal may give up some performance over time, but considers it a small price to pay to avoid relatively riskier trades. In 2010, for instance, that model cut sharply into performance even though the fund handsomely surpassed the category. In 2012, the overextended model added about 2.5% to the fund's performance. That year, large price swings in commodities decimated managed-futures funds, but this fund actually gained 3.0% thanks to the fixed-income component of its long-term trend model.

While 2013 might have been another disappointment for managed futures, this fund remained on top, climbing 9.4% compared with a 1% loss for the category. The fund was able to capture nearly 6% from its equity allocation of its long-term trend model. As other funds focus less on long-term trends, this fund's broadly diversified strategy clearly paid off. Although its performance wasn't as robust as other other equity-based alternative funds, managed futures are a separate strategy entirely. Compared with its peers', this fund's performance was topnotch.

Michael Aronstein, MainStay Marketfield MFLDX 
2013 Return: 16.9%
Morningstar Category Rank (Percentile): 38

MainStay Marketfield's macro-based process is no stranger to the nomination roster. Its stellar long-term record and relatively good absolute returns have led to a second-consecutive nomination for Michael Aronstein. Back in 2008, he maneuvered the financial crisis by shorting bank stocks such as Goldman Sachs GS and Wachovia. But while other funds hibernated, Marketfield didn't stay bearish for long. In 2009, management retooled the fund for growth--paring back the fund's shorts and tilting its longs into large-cap growth stocks. The fund posted an impressive 31.1% gain, compared with 10.5% for the category and 26.5% for the S&P 500. Subsequently, the fund has beaten its category every calendar year on an absolute basis. For 2013, the fund gained 16.9%, compared with 14.6% for the long-short category.

The key to MainStay Marketfield's success lies in its macro-based process. Since 2004, Michael Aronstein, the fund's sole manager, and Michael Shaoul, the firm's CEO, have been writing macroeconomic commentary. Their macro research feeds into various portfolio themes that the fund typically executes with ETFs. Since mid-2009, for instance, the duo has been bearish on many emerging-markets economies, most notably Brazil. That year, they also added a sizable position in a regional bank ETF, as they thought that area would prosper from the financial mess. More recently, Aronstein thought that emerging-markets bond prices were extremely overvalued; he started shorting the iShares JPMorgan USD Emerging Markets Bond ETF EMB back in the first quarter of 2012. He also added a Japanese ETF, iShares MSCI Japan EWJ, in the first quarter of 2013, as he thought the country's new government policies would reignite growth. But performance hasn't always been perfect. This year, some of the fund's moves have hampered its risk-adjusted returns.

The fund has produced a sizable amount of alpha (compared with the S&P 500) almost every year since inception. But in 2013, its alpha turned slightly negative, on par with the long-short category's. Its Sharpe ratio fared worse--2.4 for the fund, compared with 2.9 for the category. The worse risk-adjusted returns were partially caused by holding riskier assets, such as the Japanese ETF and a Mexican ETF; the latter took a beating last year. But the fund was able to beat the category on an absolute basis thanks to its higher beta or market exposure. More important, over the long term, this fund has been a solid performer.

Click to see our 2013 Domestic-StockInternational-StockFixed-Income, andAllocation Manager of the Year Nominees (winners will be announced on Jan. 15), and click here for a list of past Fund Manager of the Year winners.



[1] The figures include the Nontraditional bond category, which is a mix of alternative and nonalternative strategies. Not including the nontraditional bond category, total inflows for 2013 were $37 billion and asset growth was 39%, through November.

 

Josh Charney is an alternative investments analyst at Morningstar.

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