I attended an Alternatives Investment Symposium last week in downtown Chicago where some great information was shared. The topic “what exactly is an alternative” was discussed as the question comes up quite a bit from clients and prospects of advisors.
There really is no one true definition, but most experts agree on four key elements:
- An alternative can mean an alternative asset class – Alternatives can simply be anything that is not considered a traditional asset class like stocks, bonds, or cash. Interestingly, an alternative today may not be an alternative 10 years from now, the same way emerging markets used to be considered an alternative but are a mainstream traditional today.
- An alternative can mean an alternative investment strategy – Alternatives can be something where you are using a traditional asset class but in an alternative investment strategy. For example, a long/short equity fund utilizes stocks but it is alternative in its investment strategy approach, i.e. it can go short.
- An alternative is alternative because it is generally non-correlated to the traditional markets – In other words, alts zig when the rest of your portfolio zags. Why is this such a good thing? Because by complementing your traditional asset classes with alternatives, your portfolio will have a tighter range of return outcomes (aka “ a smoothing effect”) which translates into smaller downsides. Smaller downsides mean better geometric compounding, and hence better long-term returns. Investor psychology studies and personal experience remind us that not everyone is a fan of non-correlation when stocks are roaring, but the fact is one cannot count on 20%+ stock returns year in and year out. Not to mention that the 30yr+ bond bull market is over. One must look elsewhere for proper diversification, real positive returns, and protection of the portfolio.
- One needs at least 15% in alternatives to really make a difference – For those that understand the Efficient Frontier, this is what you need to move your portfolio up and to the left! To enhance the risk-adjusted profile of your portfolio, you want at least 15% in alternatives to complement the traditional part of your portfolio.
Now on to this month’s focus: Mainstay Marketfield Long/Short Fund (symbol: MFLDX). A long/short equity investing strategy takes long positions in stocks that are expected to appreciate and short positions in stocks that are expected to decline. A long/short strategy seeks to minimize market exposure – we finance industry folk like to say reduce beta – while profiting from the stock gains in long positions and the price declines in the short positions. A similar strategy is a market-neutral strategy where the dollar amounts of the long and short positions are equal. In this case, market beta would be zero. One doesn’t care which direction the market is headed as long as the stock picking / manager ability is going the right direction. And for MFLDX, it sure has. It’s been in the top 3% of all long/short equity funds for the last five years. The fund is up over 11% per annum vs the S&P500’s 10% per annum total return in the last 5 years while taking on about ½ the risk (0.57 beta).
Like most long/short managers, the beta moves from 0.3 to 0.8 depending upon their outlook, so there almost always is a net long bias. That said, it can offer equity market participation with some downside protection. MFLDX is a great example of an alternative investment strategy that utilizes traditional investment vehicles.
In the past two years, more than 150 alternative mutual funds have been launched, up from a little more than 100 between 2008 and 2010. $25 billion has flowed into these funds in 2013 alone. You’ll be hearing more and more about these as this area just gets more popular. It’s our job to help filter through the noise and find the good ones. We will continue to keep you informed through communications such as these.