The six-year bull market in U.S. stocks has recently come under pressure, casting doubt as to whether the Federal Reserve is likely to hike interest rates in the U.S. later this year. That should be bullish for bonds, but with rates and coupon payments already so low, there seems to be very limited upside for fixed income.
The proliferation of alternative mutual funds is largely attributable to these two factors – stocks being near all-time highs and interest rates being near all-time lows – along with the memories of two significant market meltdowns since the turn of the century. This proliferation, in turn, has created the need for education regarding the opportunities and limitations of alternative funds, at least in the opinion of Morgan Stanley Wealth Management. To this end, four of the firm’s leading members – two executive directors, one managing director, and an analyst – recently authored a white paper titled Investment Primer: Alternative Mutual Funds.
Liquid Alts Growth
Alternative mutual funds typically pursue strategies similar to those employed by hedge funds. These strategies include long/short equity, market neutral, managed futures, global macro, and event driven, among others, which hadn’t been widely available to non-accredited investors prior to the advent of liquid alternatives. Demand from the so-called “mass affluent” market – which consists of investors with between $100,000 and $1 million in liquid assets – along with additional demand from high-net-worth and institutional investors who value liquid alts for their liquidity and transparency, has resulted in the number of alternative mutual funds leaping from 171 in 2008 to 493 by the end of 2014.
Liquid Alts vs. Hedge Funds
How have liquid alts compared to their hedge-fund counterparts? In the white paper, Morgan Stanley’s Alper Daglioglu, Daniel Maccarrone, Eric Kim, and Haillie Greitzer compare the returns of three Morningstar liquid alternative categories to their respective HFRI Hedge Fund Indexes. The findings: Long/short equity mutual funds have performed more closely to their hedge-fund cousins than have the more complex managed futures and multi-strategy categories:
The mainstream media often portrays hedge funds – and by extension, liquid alternatives – as employing heavily leveraged and risky strategies designed to generate market-beating returns. In reality, most hedge-fund and liquid alternative strategies are “hedged” and designed primarily to dampen volatility, limit drawdowns, and enhance risk-adjusted returns. But individual strategies, and combinations thereof, can be utilized in pursuit of a variety of outcome-based goals, including:
- Balanced growth
- Market growth
- Opportunistic growth
The table below shows how each of these goals can be pursued with liquid alternative exposures, along with the traditional asset classes normally employed in pursuit of the goals, and Morgan Stanley’s suggested benchmarks for the various objectives:
MSWM Advisory Platform
Morgan Stanley’s Wealth Management Advisory platform has seen its number of approved liquid alts funds grow in recent years, and there are now nine distinct alternative fund types available on the platform, and a total of 58, as of May 13, 2015:
Growth in the number of funds has presented investors with new opportunities to diversify their portfolios, and this should benefit “mass affluent” investors, in Morgan Stanley’s view. The paper’s authors conclude by stating they think the number of skilled managers adopting liquid alternative strategies for the funds will grow, and that liquid alts will continue to appeal to both retail investors and high-net-worth and institutional investors.
For more information, download a pdf copy of the white paper.