Morningstar's 2014 Alternatives Fund Manager of the Year Nominees

Today we announce the final group of nominees for Morningstar's Fund Manager of the Year awards. The winners of all five categories--Domestic Equity, International Equity, Fixed-Income, Allocation, and Alternatives--will be announced on Jan. 21.

Morningstar's three candidates for Alternatives Fund Manager of the Year did more with less. And by "less," I mean less market exposure than their long-only equity compatriots. Most alternative funds hedge away some portion of market risk, resulting in lower betas than traditional stock funds, which usually have betas near 1.0 or higher. In contrast, the three nominees for Alternatives Fund Manager of the Year had betas in 2014 ranging from 0.11 (in other words, systematic market exposure of virtually nil) to 0.63. Thus, even though these funds' absolute returns may appear weak relative to the S&P 500, to generate positive returns their managers had to generate a higher share of alpha, or pure stock-selection skill (and potentially on the short side as well as the long side of the portfolio). While a fund's returns relative to its peers and benchmarks was an important factor in considering nominees, equally important when evaluating alternative managers are their risk-adjusted returns and alpha generation.

Many mutual funds that pursue alternative strategies have relatively short records, and the pool of alternative managers with Morningstar Analyst Ratings of Gold, Silver, or Bronze is small, reflecting the paucity of experienced managers. But the managers representing this year's nominees all have lengthy histories running mutual funds and/or predecessor hedge funds, and we're confident in their ability to execute the higher degree of difficulty often associated with shorting or running quantitative models, each technique of which is represented among our candidates.

Robert Jones and Ali Motamed, Boston Partners Long/Short Equity (BPLEX , BPLSX ) 2014 Return: 4.72% Morningstar Category Rank (Percentile): 35

This first-time nominee manages one of the longest-tenured alternative mutual funds. Lead manager Robert Jones took over the fund in 2004, when the strategy was overhauled to its current approach. (Ali Motamed, a longtime analyst on the fund, was promoted to the named management team in 2013). Jones has earned outstanding long-term results for the fund by actively investing in stocks long and short. The long book usually stays around 95% invested, while short exposure can range between 10% and 80%, depending on the opportunities management finds. In 2014, the fund's category-beating 4.7% return was particularly notable given the fund's low average net exposure of 34% and a weekly beta for the year of only 0.12. Jones managed to produce alpha from the short portfolio--no easy task in a strong year for the stock market--with gains in stocks such as

Robert Goldstein and Joel Greenblatt, Gotham Absolute Return (GARIX) 2014 Return: 9.31% Morningstar Category Rank (Percentile): 14

Managers Joel Greenblatt and Robert Goldstein have been running this mutual fund only since August 2012, but they've managed a similar hedge fund version since 2009. Moreover, they have been running concentrated long-short strategies at Gotham Capital for more than 25 years. The process at its core involves ranking stocks on a series of value metrics and investing in the highest-ranked 400 and shorting the bottom 400. What distinguishes the strategy is the proprietary technique the managers have developed for scrubbing financial statements, which its team of 11 analysts regularly executes. Returns have been impressive so far, with 2014 standing out: its 9.3% return topped the long-short equity Morningstar Category average by more than 6 percentage points, with a beta to the S&P 500 of only 0.63 (that is, however, a higher exposure than the average long-short fund). That followed a 2013 return of around 30%. Fees remain a sticking point here, with a 2.2% expense ratio that smacks more of hedge fund prices. This presents a tough long-term hurdle, but Greenblatt and Goldstein have more than earned their fee so far. Both managers have also bet their own money on the fund, investing more than $1 million apiece.

James Troyer, Michael Roach, and James Stetler, Vanguard Market Neutral (VMNFX , VMNIX ) 2014 Return: 4.38% Morningstar Category Rank (Percentile): 15

The final candidate is in many ways the least likely. Vanguard is not known for its enthusiasm about alternatives. But James Troyer, Michael Roach, and James Stetler, of Vanguard's quantitative research team (part of the active equity group), have employed Vanguard's trademark emphases on simplicity and cost to create a market-neutral fund that works better than most of the competition. The management team has run at least a sleeve of the fund since Vanguard purchased it from Schwab in 2007, but it's had sole ownership of the record since 2010, after Vanguard fired the other subadvisor, Axa Rosenberg, and tweaked the models. The managers have amassed a strong record since then, using a five-factor model to rank stocks across every GICS industry, keeping net exposure very close to zero, and betting that long positions in stocks with positive rankings will outperform baskets of shorts with negative rankings. In 2014, the fund returned 4.4%, eighth best in the market-neutral Morningstar Category, and a strong absolute figure given the fund's beta of 0.01 for the year. Bare-bones expenses give the fund a pronounced and continuing edge over its peers--a welcome thriftiness in the generally overpriced alternatives universe.