Nominees for 2015 Alternatives Fund Manager of the Year

As did managers in other asset classes, alternative-fund managers faced a host of challenges in 2015: muted stock and bond market returns, plummeting commodities, tricky currency markets, and greatly increased volatility. Of course, many alternative funds are designed to take advantage of such circumstances: They can go short declining markets, for instance, or they have the latitude to move across global asset classes and markets to find the best opportunities. That doesn't mean everyone succeeded, however. In the difficult third quarter, managed-futures funds displayed their historical diversifying traits, with the category up 0.68% for the quarter while the MSCI World Index declined nearly 9%. But overall, the results for alternative managers during the correction were somewhat equivocal.

It's the managers who stood out, both during the downturn and over the course of the year, that drew our attention when nominating candidates for Morningstar Alternatives Fund Manager of the Year. We looked, in the first place, for managers who produced positive absolute returns as well as favorable relative returns compared with their category peers. That alone filtered out many managers. But beyond returns, we look for managers whose strategies embody the types of qualities investors typically seek in an alternative fund, such as diversification away from traditional stock and bond exposures and improved drawdown behavior. Did the manager produce alpha from shorting, adjust market exposure in a timely and beneficial manner, and/or produce positive returns when other markets were tanking? Moreover, has the manager proved an ability to do this over the long term? (Though long term, when it comes to alternative funds, may only mean five or six years.)

The three nominees for 2015 Alternatives Fund Manager of the Year meet those criteria, showcasing the best characteristics of alternative mutual funds. The winner will be announced on Jan. 26.

Joseph Feeney and Eric Connerly

Boston Partners Long/Short Research BPIRX

2015 Return: 1.52%

Morningstar Category Rank (Percentile): 23

Boston Partners is no stranger to our Alternatives Fund Manager of the Year nomination list. Stablemate

Indeed, in 2015, the short book contributed most of the fund's return, particularly in the energy sector, where the analysts identified low-quality, leveraged exploration and production companies like

Guy Stern

John Hancock Global Absolute Return Strategies

JHAAX

2015 Return: 1.73%

Morningstar Category Rank (Percentile): 7

This mammoth fund proves that size need not get in the way of agility. Lead manager Guy Stern oversees a 50-person team of investment professionals at Standard Life, the Scotland-based asset manager that subadvises the U.S. version of the strategy for John Hancock. While the U.S. fund itself stands at $9 billion, worldwide the strategy now manages around $75 billion, raising concerns about whether it can continue to produce competitive performance. Somewhat easing those worries is the fact that Stern and company use highly liquid instruments, usually futures, to execute its global-macro approach. Stern, the head of multiasset investing, has been a named manager on this fund since its 2011 inception and a comanager on the U.K. version since 2008. Standard Life has seen several key departures during the past few years, but Stern was one of the strategy's original architects.

The strategy seeks to generate returns of cash plus 5% over rolling three-year periods by tactically investing in global stock, bond, and currency markets. Members of the investment team regularly generate new trade ideas, which are supposed to be profitable over a three-year period. Stern chooses which trades to include based on the degree of analyst conviction and the expected correlation to other trades in the portfolio. The trades are classified into one of three main buckets: long-only bets on equities and bonds, relative-value pair trades (such as long Nasdaq stocks versus short small caps), and currency bets (such as long the U.S. dollar versus the euro). The 10-person risk team, a critical component of the strategy's success, also assists in sizing and monitoring positions.

The fund's 1.73% return in 2015 topped more than 90% of category peers, and its since-inception annualized return of 4.59% far exceeds the multialternative category average while coming close to its absolute return target. In 2015, the fund's trade of long the U.S. dollar and short the Canadian dollar was its most profitable, but other currency trades also contributed. Moreover, management adroitly removed the fund's long beta exposure to U.S. equities in the second quarter, providing a relative advantage when U.S. equity markets slumped. It's difficult to consistently get macro calls right, but Stern and his experienced team have proved to be more adept than most.

James Troyer, Michael Roach, and James Stetler

Vanguard Market Neutral VMNIX

2015 Return: 5.52%

Morningstar Category Rank (Percentile): 12

The management team of Vanguard Market Neutral was also nominated in 2014. Simply put, this fund has produced what investors want from alternative strategies: very low correlation, solid returns when equity markets go south, and on top of that the lowest fees of any alternative fund. The three managers are all long-tenured members of Vanguard's quantitative-equity group; James Troyer has been a named manager on the fund since 2007, while Michael Roach and James Stetler were added in 2012. Vanguard has been the sole manager on the fund since October 2010, when it dropped AXA Rosenberg as a subadvisor. From that point, the fund's 4.2% annualized return and 0.95 Sharpe ratio are the best in the market-neutral category through December 2015.

The management team has developed a five-factor quantitative model intended to identify stocks likely to grow their earnings faster than industry peers but are trading at inexpensive valuations (and, in the case of this fund, to short those demonstrating opposite characteristics). The managers construct the portfolio to be market-neutral by industry and size, while individual positions are capped at 0.5%, so performance is ultimately driven by the aggregate ability of its model's highly ranked stocks to outperform the low-ranked stocks within an industry. In 2015, the fund came through when it mattered most for investors. During the volatile third quarter, when the S&P 500 lost 6.4%, this fund gained 7.0% as its short positions fell far more than its longs. Vanguard's low-fee cost structure gives this fund an ongoing advantage (the retail shares charge only 0.25% annually), with the caveat that the lowest minimum investment is a steep $250,000, as Vanguard hopes to prevent investors from misusing the fund.