Nadia Papagiannis: Hello, my name is Nadia Papagiannis. I'm an alternatives analyst here at Morningstar.
Today with me I have Rick Lake, co-founder of Lake Partners and manager of the Aston/Lake Partners LASSO Alternatives Fund, which is a fund of all alternative mutual funds.
Lake Partners has been on the forefront of using mutual funds with alternative strategies, and LASSO, or the Long and Short Strategic Opportunities strategy, has been around since 1999, which is a lot longer than a lot of alternative funds out there.
Lake Partners, in fact, has been consulting on alternative strategies since 1989, so this is their 20th anniversary.
Rick, thanks for being here with us today.
Rick Lake: Delightful to be here.
Papagiannis: While we've seen the number of alternative mutual funds pretty much explode in recent years, I was wondering if you could tell us both the regulatory impetus for this and also the investment case for all of these alternative funds.
Lake: Well, the investment case goes back quite a way. Mutual fund managers, to a very limited degree, tried to incorporate short selling, and option hedging, and alternative strategies for quite a while.
But the freedom to do it really did not occur until 1997, when Congress repealed an old tax law called the short-short rule, which used to limit the amount of short-term trading, including short selling, that a mutual fund could do. Once this rule was repealed, it allowed those mutual funds that were short selling or using other alternative strategies to do it even more. In 1998, we saw the creation of the first wave of dedicated long-short and alternative mutual funds.Read Full Transcript
Papagiannis: Along those lines, the restrictions on mutual funds, are they too restrictive for these alternative strategies?
Lake: Well, that's always subject to debate. The restrictions relate to illiquid securities and leverage. After last year, restrictions on illiquid securities and leverage are considered a good thing.
Papagiannis: Yes, definitely. What about the investment case? What's the case for people having alternatives in their portfolio? Do you think that people are starting to see the light?
Lake: The reason to have alternatives is to have the tools to manage risk, to turn your risk dial up or down, to bring risk down when times might seem perilous, or to increase your risk exposure when the opportunities are there.
Alternatives also provide an investor or a manager ... different sources of return for their portfolio besides conventional market exposure. So the case is very powerful--sources of risk control and additional sources of return.
Papagiannis: What is your definition of an alternative strategy?
Lake: For LASSO, we have three criteria to determine whether or not a fund uses alternatives.
Criterion number one is it needs to use short selling on an ongoing, regular, or periodic basis. By periodic, a fund could be short for a period of time and then not in the next period, but as long as they short sell periodically, it meets our definition.
The second criterion is hedging. Does a fund use options, futures, or other hedging strategies as a tool to manage risk?
Our third criterion is does a fund employ alternative strategies such as leverage, derivatives, commodities, or private placements?
Papagiannis: How much of these strategies should people put in their portfolios?
Lake: Well, that's a question that's always subject to review.
In the endowment world, which for many years was considered the cutting edge of investment thought, it's not unusual to see a 40% allocation to alternatives, which is the average of all large endowments. Some will even go higher than that.
In the retirement community, asset allocators building model balanced programs for plan participants may go 20% alternatives. So the solutions vary depending on the client.
Papagiannis: Sometimes do you feel that advisors are hesitant to put a large allocation into alternatives just because they're new? Does that really correspond to the actual risk inherent in these alternative strategies?
Lake: It's an issue people are often--or some people are reluctant to use new investments, and they'll stick with the conventional. But just because something's conventional doesn't mean it isn't risky. Your conventional assets, which may all be moving in the same direction, may carry quite a bit of risk together.
An investor or professional might think, well, if I do something conventional, I'm not doing anything wrong. But by doing what's conventional at the wrong time, they might have been better off looking at the alternatives.
Papagiannis: Exactly. Well, thank you so much, Rick, for being with us today.
Lake: Thank you. Great to be here.