Three Flavors of Multialternative Funds

Josh Charlson: Today I'm going to be breaking down the Morningstar multialternative category. Funds in this category either invest in or implement multiple alternative strategies within one portfolio. This has been a very fast-growing category; from fewer than 20 funds in 2008, we now have more than 150 funds in the category. So it's helpful to break it down and try to make some sense of the distinct strategies within it.

The largest grouping of funds within the multialternative category is what we call multistrategy funds. And these are funds where the managers are making distinct allocations to separate alternative strategies and those can be either through hedge funds that they invest in through separate accounts; through mutual funds in a traditional fund-of-funds format; or single-strategy funds where it's a single manager operating in different sleeves within the fund.

The second major grouping is global macro funds, and these are very flexible funds where managers can go long or short across global regions and asset classes. You often see a lot of currency trades, pairs trading buckets in these funds and they also use liquid instruments like futures and forward contracts.

The smallest grouping that's a distinct grouping within the category is hedge fund replicators. These are quantitative strategies that use regressions to identify and harvest the factors that drive hedge fund returns, often called hedge fund betas.

Investors considering a multialternative fund will first want to identify which of these three major types of strategies the fund they are looking at actually follows because each one can have different risk and return characteristics. So this should be a good framework for taking the next step of research into a multialternative strategy.