(PUB) Investing 2016

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Making Sense of Multialternative Funds Morningstar Research | Josh Charlson

portfolio, using a variety of techniques and structures. Although portfolio managers may alter their alloca- tions to the sleeves over time, the allocations are gen- erally fairly static or strategic in nature. Approximately two thirds of funds in the category use a multistrategy approach. Within the multistrategy bucket, there are several distinct subtypes: Multistrategy–Fund of Hedge Funds: These funds use managed-account structures to directly access hedge fund strategies. Multistrategy–Single-Manager: These funds rely on the internal expertise of the asset manager to allocate across teams or strategy types within the firm. Global Macro: Global-macro managers have the flexi- bility to invest long and short across global asset classes and markets. Allocation decisions tend to be based on a mix of macroeconomic factors (such as interest rates) and more-fundamental rationales (such market valuations in one region versus another). Global-macro funds typically use liquid futures to carry out their ideas and often have significant currency components, and many often rely on buckets of pair trades (when long and short ideas on a set of securi- ties are matched within a certain sector, for example). Hedge Fund Replication: Whereas most multialter- native funds are premised on the notion of manager skill, hedge fund replicators take a different tack: Proponents of these funds take the view that most hedge fund returns can be traced to market factors, or beta, and that those factors can be identified and replicated through sophisticated regression tech- niques. There is academic support to this viewpoint, but the real-world results have been fairly disap- pointing. Hedge fund replication mutual funds, of which there are a handful, are among the cheapest multialternative strategies available. How Have Multialternative Funds Performed? Most multialternative funds are designed as moderate-return, lower-volatility vehicles that should Multistrategy–Fund of Mutual Funds: These funds employ a traditional fund-of-funds structure.

Recent stock market volatility has served to remind investors of the potential role of alternatives in a diversi- fied portfolio. Alternative mutual funds use asset classes and strategies designed to have low correlation with traditional stocks and bonds, thus in theory pro- viding ballast to a portfolio when the markets are rocky. One of the most popular entry points for investors considering alternative strategy mutual funds has been the multialternative Morningstar Category. Multi- alternative funds, as their name suggests, combine multiple alternative strategies and asset classes within a single portfolio, making them a natural starting point for investors who want alternatives exposure but lack the know-how to research, select, and combine single-strategy alternative funds on their own. But multialternative funds also present challenges. The multialternative category is extremely heteroge- nous, and performance is widely dispersed. Most funds have relatively short track records (as is the case across alternative categories). Moreover, fees tend to be higher than those of both traditional long-only funds and single-strategy alternative funds. Finally, performance has been somewhat disappointing. For all these reasons, it’s important when selecting a multialternative fund to choose a highly experienced management team running a reasonably priced fund. Breaking Down the Multialternative Category First, it will be helpful to break down the varying types of approaches within the category. We have identified three main substrategies within the multialternative category, and there are some further nuances within those strata. Those three substrategies are multi- strategy, global macro, and hedge fund replication. Multistrategy : The multistrategy approach is by far the most common in the category. Multistrategy funds allocate to distinct alternative strategy sleeves in the