liquid alternatives challenges and opportunities...• macro investing struggles • illiquidity and...
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©2018 Morningstar, Inc. All rights reserved.
Tayfun Icten Multi-Asset and Alternative Strategies
28 February 2018
Liquid Alternatives – Challenges and Opportunities
Rates Matter for Alternatives
Hedge Fund Index Returns vs. U.S. 10-Year Yield (15-Year Window)
2
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
12
/1/2
00
3
4/1
/20
04
8/1
/20
04
12
/1/2
00
4
4/1
/20
05
8/1
/20
05
12
/1/2
00
5
4/1
/20
06
8/1
/20
06
12
/1/2
00
6
4/1
/20
07
8/1
/20
07
12
/1/2
00
7
4/1
/20
08
8/1
/20
08
12
/1/2
00
8
4/1
/20
09
8/1
/20
09
12
/1/2
00
9
4/1
/20
10
8/1
/20
10
12
/1/2
01
0
4/1
/20
11
8/1
/20
11
12
/1/2
01
1
4/1
/20
12
8/1
/20
12
12
/1/2
01
2
4/1
/20
13
8/1
/20
13
12
/1/2
01
3
4/1
/20
14
8/1
/20
14
12
/1/2
01
4
4/1
/20
15
8/1
/20
15
12
/1/2
01
5
4/1
/20
16
8/1
/20
16
12
/1/2
01
6
4/1
/20
17
8/1
/20
17
HF Return - Left Axis 10-Year Yield - Right Axis
Source: Morningstar Source: Morningstar, Inc.
3
Long-Term Returns Have Eroded
60/40 Portfolio vs. Credit Suisse Hedge Fund Index
0%
2%
4%
6%
8%
10%
12%
14%
12
/20
03
4/2
00
4
8/2
00
4
12
/20
04
4/2
00
5
8/2
00
5
12
/20
05
4/2
00
6
8/2
00
6
12
/20
06
4/2
00
7
8/2
00
7
12
/20
07
4/2
00
8
8/2
00
8
12
/20
08
4/2
00
9
8/2
00
9
12
/20
09
4/2
01
0
8/2
01
0
12
/20
10
4/2
01
1
8/2
01
1
12
/20
11
4/2
01
2
8/2
01
2
12
/20
12
4/2
01
3
8/2
01
3
12
/20
13
4/2
01
4
8/2
01
4
12
/20
14
4/2
01
5
8/2
01
5
12
/20
15
4/2
01
6
8/2
01
6
12
/20
16
4/2
01
7
8/2
01
7
HF 10 YR Roll 60/40 10 YR Rolling ReturnSource: Morningstar, Inc.
4
Liquid Alternative Mutual Funds Continue to Grow
Despite the weakness in long-term returns, liquid alts have experienced reasonable growth.
0
50,000,000,000
100,000,000,000
150,000,000,000
200,000,000,000
250,000,000,000
Total Net Assets
$ Billions
Source: Morningstar, Inc.
5
Some Alternatives Have Grown Faster Than Others
Asset Growth by Morningstar Category
0
10,000,000,000
20,000,000,000
30,000,000,000
40,000,000,000
50,000,000,000
60,000,000,000
Long Short Credit
Long Short Equity
Managed Futures
Market Neutral
Multialternative
Multicurrency
Options-Based
$ Billions
Source: Morningstar, Inc.
6
Some Alternatives Categories Are Seeing Outflows
Estimated net flows, organic growth, and total assets as of January 2018.
Morningstar Category 1-Mo QTD YTD 1-Yr
Organic Growth Rate % (TTM)
Total Assets
($Bil)US Fund Multialternative 1,083 1,083 1,083 2,889 5.77 56 US Fund Long-Short Equity 992 992 992 2,942 8.84 41 US Fund Managed Futures (116) (116) (116) (2,162) (8.52) 25 US Fund Market Neutral 331 331 331 414 2.01 22 US Fund Options-Based 276 276 276 1,330 8.70 17 US Fund Long-Short Credit (8) (8) (8) (480) (6.26) 7 US Fund Multicurrency (14) (14) (14) 325 5.53 7
© Copyright 2018 Morningstar, Inc.
7
Performance Improves for Alts Categories in 2017, With Some Unexpected Results in 2018
Name 2017
Perf.
3 Year
Ann.
5 year
Ann.
5-Year
Beta to
60/40
5 Year
Beta to
SPX
Recent
Sell-Off
Jan 26th
to Feb 8
5-year
Sharpe
25-Year
Sharpe
60% AGG - 40% VTI 10.4% 6.2% 7.3% 1.00 0.40 -4.8% 1.63
US Fund Long-Short Equity 11.2% 5.8% 6.2% 1.02 0.51 -6.3% 1.04 0.53
US Fund Options-Based 9.1% 5.4% 5.2% 0.88 0.42 -8.1% 1.21 0.50
US Fund Multialternative 5.1% 2.0% 2.6% 0.66 0.27 -4.0% 0.50
US Fund Managed Futures 3.0% 0.1% 3.8% 0.34 0.05 -8.6% 0.25
US Fund Long-Short Credit 2.4% 1.7% 1.5% 0.38 0.14 -0.9% 0.44
US Fund Market Neutral 2.4% 1.1% 1.2% 0.18 0.09 -1.4% 0.99 0.27
US Fund Multicurrency 0.8% 0.5% -0.5% 0.32 0.11 -0.4% -0.09 -0.10
SPDR® S&P 500 ETF 21.7% 14.5% 15.8% 2.03 1.00 -10.1% 1.56 0.55
Average Beta 0.54 0.23
Source: Morningstar, Inc.
8
Alternatives Provided Some Downside Protection From Peak to Trough
Alts category returns versus major asset-class performance
Name Recent Market
Turbulence from
Jan 26 to Feb 8
CBOE Market Volatility (VIX) 201.44
US Dollar 1.3%
US Fund Multicurrency -0.4%
iShares 3-7 Year Treasury Bond ETF -0.4%
US Fund Long-Short Credit -0.9%
BBgBarc US Agg Bond TR USD -1.0%
US Fund Market Neutral -1.4%
BBgBarc High Yield Corporate TR USD -1.4%
SPDR® Gold Shares -2.8%
US Fund Multialternative -4.0%
US Fund Long-Short Equity -6.3%
United States Oil -7.5%
US Fund Options-based -8.1%
US Fund Managed Futures -8.6%
iShares MSCI Emerging Markets ETF -8.6%
iShares Edge MSCI Min Vol USA ETF -9.1%
S&P 500 TR USD -10.1%
NASDAQ 100 TR USD -10.2%
iShares Edge MSCI USA Value Factor ETF -10.2%
iShares Edge MSCI USA Momentum Fctr ETF -10.3%
SG Trend Index -11.9%
Average Alts Category Performance -4.2%Source: Morningstar, Inc.
9
Multialternative: Category Considerations and Medalist Performance
(3-Year period ending January 2018)
Category Considerations
• Roughly 0.3 average beta • Most heterogeneous • Global-macro return
drivers• Style-premium return
drivers• Other alternative betas • Asset-allocation models• Traditional fundamental
long-short • Hedge fund replication
products• Macro investing struggles• Illiquidity and credit
concerns
Name Morningstar Analyst Rating
3-Year Ann. Return
AQR Style Premia Alternative I Silver 7.6%
Goldman Sachs Absolute Ret Trckr Instl Bronze 4.6%AQR Style Premia Alternative LV R6 Silver 4.4%
Litman Gregory Masters Alt Strats Instl Bronze 3.6%AQR Multi-Strategy Alternative I Bronze 3.4%Principal Global Multi-Strategy Instl Bronze 3.2%WCM Alternatives Event-Driven Instl Bronze 2.5%GMO SGM Major Markets III Bronze 2.1%Dreyfus Global Real Return I Silver 1.7%
JHancock Global Absolute Ret Strats NAV Bronze 0.9%William Blair Macro Allocation I Bronze 0.5%
Multialternative Category Average 2.0%Morningstar Medalist Average 3.1%
Source: Morningstar, Inc.
10
Long-Short Equity: Category Considerations and Medalist Performance
(3-Year period ending January 2018)
Category Considerations
• Average beta 0.5
• Pure company-specific risk
• Factor-based risk premia
• Risks other than single stock specific
• Often downside protection in mind
• Seek market dislocation
Name Morningstar Analyst Rating
3-Year Ann.
Return
AQR Long-Short Equity I Bronze 15.72Boston Partners Long/Short Equity Instl Bronze 9.82
Schwab Hedged Equity Bronze 8.34
Diamond Hill Long-Short I Bronze 7.47
Boston Partners Long/Short Rsrch Instl Silver 7.24Boston Partners Global Long/Short Instl Bronze 6.38
Long-Short Equity Category Average 5.8%
Morningstar Medalist Average 9.2%
Source: Morningstar, Inc.
11
Market Neutral: Category Considerations and Medalist Performance
(3-Year period ending January 2018)
Category Considerations
• Zero beta
• Factor long-short
• Merger spreads and deal volume
• Multiple dimensions in neutrality
• Low short rates are not good
• Subject to factor crash risk
• Leverage
Name Morningstar Analyst Rating
3-year Ann.
ReturnAQR Equity Market Neutral I Bronze 9.4%AQR Diversified Arbitrage I Bronze 2.9%Touchstone Merger Arbitrage Instl Bronze 2.7%AC Alternatives® Market Neutral Val I Bronze 2.5%Arbitrage I Bronze 2.5%Merger Institutional Bronze 2.3%BlackRock Global Long/Short Equity Instl Bronze 1.3%Vanguard Market Neutral I Silver 1.2%
Market-Neutral Category Average 1.1%Morningstar Medalist Average 3.1%
Source: Morningstar, Inc.
Managed Futures: Category Considerations and Medalist Performance
(3-Year period ending January 2018)
12
Source: Morningstar, Inc.
Name Morningstar Analyst Rating
3-Year Ann.
Return
American Beacon AHL Mgd Futs Strat Instl Bronze 2.2%
Credit Suisse Managed Futs Strat I Bronze 1.2%Natixis ASG Managed Futures Strategy Y Bronze -0.5%
Abbey Capital Futures Strategy I Bronze -0.5%
AQR Managed Futures Strategy I Bronze -2.8%
AQR Managed Futures Strategy HV I Bronze -4.9%
Managed-Futures Category Average 0.1%
Morningstar Medalist Average -0.9%
Category Considerations
• Zero beta with some spikes
• Systematic trend-followers dominate
• Time series momentum
• Volatile periods and max drawdown
• Margined derivative accounts, but not short vega
• Not a 100% hedge
• Must understand margin/equity ratio
Options-Based: Category Considerations and Medalist Performance
(3-Year period ending January 2018)
13
Source: Morningstar, Inc.
Category Considerations
• Market beta ranges from -0.5 to 1.0
• Systematic “outcome-based” strategies make up the core
• Consistent options-based strategies for qualification
• Very large dispersion year to date
• Watch for naked option sellers/tail risks!!!
• Look at daily returns!
• Similar to credit-sensitive bonds
• If you must, keep it small
Name Morningstar Analyst Rating
3-year Ann. Return
JPMorgan Hedged Equity I Silver 7.7%
Gateway Y Silver 6.7%
Swan Defined Risk I Bronze 4.7%AllianzGI Structured Return P Bronze 4.5%
Options-Based Category Average 5.4%Morningstar Medalist Average 5.9%
Credit Long-Short and Multicurrency: Category Considerations
14
Source: Morningstar, Inc.
• No Morningstar Medalists here
• Duration-neutral portfolios, spread assets, and static hedges
• Compressed credit spreads, no external leverage
• Beware of derivatives and structured products’ internal leverage
• After a major credit dislocation, these funds may provide better value
• Small doses to add cash plus yield, but tail risks may be hidden
• Highly heterogeneous
• The core is the “carry trade,” a global-macro risk factor
• Invest in higher-yielding currencies against the U.S. dollar
• High correlation to equities
• Other players may be net long or short the U.S. dollar
Credit Long-Short Strategy Multicurrency
Alternatives Charge More Than Double for Institutional Share Classes
15
Source: Morningstar, Inc.
Distribution Group - Alternatives
Calculated
Average Net
Expense Ratio
Distribution
Category
Median Distribution Group - Traditional
Calculated
Average Net
Expense Ratio
Distribution
Category
Median
Equity Alternative Defer Load 2.31 2.20 Small Cap Deferred Load 2.03 2.02
Equity Alternative Front Load 1.79 1.73 Small Cap Front Load 1.31 1.35
Equity Alternative Institutional 1.46 1.40 Small Cap Institutional 0.99 0.99
Equity Alternative Level Load 2.47 2.45 Small Cap Level Load 2.05 2.01
Equity Alternative No Load 1.61 1.50 Small Cap No Load 1.17 1.12
Equity Alternative Retirement, Large 1.18 1.25 Small Cap Retirement, Large 0.90 0.87
Equity Alternative Retirement, Medium 1.79 1.74 Small Cap Retirement, Medium 1.53 1.47
Equity Alternative Retirement, Small 2.20 2.20 Small Cap Retirement, Small 1.63 1.67
Managed Futures Defer Load 2.35 2.35 Intermediate-Term Bond Deferred Load 1.52 1.49
Managed Futures Front Load 2.04 1.94 Intermediate-Term Bond Front Load 0.83 0.85
Managed Futures Institutional 1.62 1.57 Intermediate-Term Bond Institutional 0.50 0.51
Managed Futures Level Load 2.66 2.69 Intermediate-Term Bond Level Load 1.53 1.49
Managed Futures No Load 1.86 1.91 Intermediate-Term Bond No Load 0.65 0.63
Managed Futures Retirement, Large 1.22 1.20 Intermediate-Term Bond Retirement, Large 0.48 0.49
Managed Futures Retirement, Medium 1.90 1.90 Intermediate-Term Bond Retirement, Medium 1.10 1.01
Multialternative Defer Load 2.07 2.08 Intermediate-Term Bond Retirement, Small 1.08 1.17
Multialternative Front Load 1.84 1.75 Large Cap Deferred Load 1.83 1.91
Multialternative Institutional 1.55 1.49 Large Cap Front Load 1.11 1.15
Multialternative Level Load 2.54 2.49 Large Cap Institutional 0.75 0.72
Multialternative No Load 1.73 1.60 Large Cap Level Load 1.89 1.78
Multialternative Retirement, Large 1.31 1.25 Large Cap No Load 0.90 0.87
Multialternative Retirement, Medium 1.87 1.72 Large Cap Retirement, Large 0.65 0.63
Multialternative Retirement, Small 2.24 2.24 Large Cap Retirement, Medium 1.32 1.22
Large Cap Retirement, Small 1.42 1.40
Institutional Average 1.55 0.75
Front Load (Class A) 1.89 1.08
Level Load (Class C) 2.56 1.82
Morningstar Fee Study Results—Alternatives’ Fund Fees Have Gone Up
16
Source: Morningstar, Inc.
Share-Class-Related Flows (All Mutual Funds)
Morningstar Direct Flows Data
17
Source: Morningstar, Inc.
All Share Class Types
Name 1-Yr (Mil)
Mkt Sh%
Jan 2018
Mkt Sh%
Jan 2017
Inst 328,669 33.14 31.49
Other 231,225 20.33 18.97
A (225,580) 13.35 15.41
No Load (133,216) 13.33 14.40
Retirement 170,098 7.12 5.90
Inv (28,249) 6.57 6.93
C (70,992) 2.55 3.28
Adv 3,133 1.29 1.33
S (7,154) 0.68 0.73
D (1,116) 0.43 0.36
N (1,362) 0.41 0.45
B 20,686 0.40 0.25
M (4,308) 0.35 0.42
Unclassified (312) 0.05 0.05
T (2,530) 0.00 0.02
© Copyright 2018 Morningstar, Inc.
Concluding Remarks
18
Source: Morningstar, Inc.
• Rates matter for alternatives.
• Lower yields on cash holdings (managed futures, merger-arbitrage, credit long-short).
• Compressed credit spreads, option premiums, and overall risk premiums.
• More dislocations and more opportunities for alternative funds?
• Capacity-related considerations.
• Consolidation is not good for alternatives.
• The battle of bots versus humans.
• Increasing quantitative equity investing, alternative data, natural language processing.
• Overcrowding effects, Quant Quake of August 2007.
• A mix of traditional versus quantitative?
• Options-based strategies are complex, perhaps some are too complex!!!
• Be wary of naked option sellers.
• Time to be mindful of stock and bond correlations as rising rates can destabilize certain markets. Some alternative strategies may help.
• And finally, most alternatives are still too expensive for what they deliver.
19
Disclosures
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