There may be no two investment firms more different than Vanguard and Goldman Sachs. But the two have found a note of harmony.
In separate presentations to financial advisers — and potential clients — at a conference in Las Vegas, investment pros from both firms agreed that advisers face a daunting task in picking the right alternative fund managers.
“I took a silent poll of all the people that are in this room, and 100% of you agreed that you've never chased performance on the upside. And, importantly, thankfully, you've never sold at the bottom,” said Jason Gottlieb, a portfolio manager at the Goldman Sachs Group Inc. and managing director of its alternative investments and manager selection group. “But what you'll find is that a lot of people are just chasing hot performance. There's one notable fund that went from a very small amount, had very good performance, to a very large amount, now has had bad performance and now you're seeing the unwinding."
That
apparent reference to the MainStay Marketfield Fund (MFADX) was matched, in its cautionary tone at least, by Brian Scott, a senior investment analyst at the Vanguard Group Inc.
MANAGER SELECTION CRITICAL
“Vanguard talks a lot about asset allocation, and how for most investors [investment selection] should be a top-down exercise. The exact opposite is true when you're thinking about alternative investments, it's very much a bottom-up exercise,” Mr. Scott said. “You really need to make sure you have top management talent."
Vanguard manages the more money in U.S. mutual funds than any other firm, $2.4 trillion, much of it deployed in passive, so-called “long-only” strategies.
Goldman Sachs, by contrast, makes most of its money from doing business with other institutions. In recent years its smaller retail business has made a heavy investment in bringing exotic hedge-fund strategies to a retail audience in a concoction called a “liquid alternative.”
“Manager selection is extremely critical when implementing hedge funds in your clients' portfolios,” Mr. Gottlieb said. “I wouldn't be mentioning this if we were talking about large-cap growth or large-cap value portfolios."
He added: “If you get it right, it can be very rewarding to your portfolio. If you get it wrong, it could be hazardous."
The two firms described their reasoning slightly differently. Mr. Gottlieb, whose focus includes running a multimanager liquid alt product, is optimistic about the space. He is a portfolio manager of the Goldman Sachs Multi-Manager Alternatives Fund (GMAMX). But he says the wide dispersion between top and bottom performers means selection of winners is tough.
His fund's “bottom-up” approach involves hiring a handful of managers in each of several hedge fund disciplines, including equity long-short and event-driven.
LESSONS FOR ADVISERS FROM BIG INVESTORS
But Vanguard, which has relatively few alternative offerings, is less sure about the long-term prospects. Mr. Scott's speech at the conference organized by the Investment Management Consultants Association Inc. focused on the lessons retail investors could learn from the experience of endowments invested in alternatives.
His definition of alternatives included the “liquid” kind, mostly mutual funds, as well as hedge funds, private equity and so-called “real” assets, such as commodities.
Mr. Scott argued that only very large endowments — like those of Harvard and Yale Universities — have been successful, primarily because of their early investment in alternatives. But most other institutional investors saw inferior results.
OVERCROWDING?
“The majority of their success, in our view, was due to their early entry into this market,” Mr. Scott said. “It's a fair point to ask the question, is there excessive crowding in the space. Can these asset classes continue to be rewarded if so many investors are investing in them?"
Most hedge funds have not even beaten a simple portfolio of 60% stocks and 40% fixed-income securities from 1994 to 2013, and they have only moderately added diversification, according to Vanguard research.
Still, while most hedge funds have failed, a good number have succeeded, Mr. Scott said. If advisory practices can match the pricing power, due-diligence and first-mover advantages enjoyed by large endowments, “we think you'll maximize the probability of success for your client,” he said.
Pointing to a different data set, Goldman's research showed an index of hedge funds delivering a greater cumulative return than bonds, commodities and global stocks from 1994 to 2014. They also delivered smaller “drawdowns” than stocks over that period, Mr. Gottlieb said, referring to a worst-case measure of a portfolio's drop in value.
In addition to return potential, Mr. Gottlieb argued that hedge fund strategies continue to offer greater flexibility for managers to sidestep market risk and diversify portfolios. He disagreed with Mr. Scott's assessment of hedge funds as failing to deliver on their promise of diversification.
LIQUID ALTS' RISK
Mr. Gottlieb added the fast-growing liquid alts universe includes considerable risks. Among them is the potential for operational failures among hedge-fund managers who are grappling with new regulatory requirements in managing mutual fund strategies.
And he said advisers who buy liquid alts based on “the story” — or marketing narrative — and past performance could harm clients.
“We think that's a flawed strategy,” Mr. Gottlieb said.
Without naming any specific competitors, he accused some fund companies that build funds of funds of increasing the potential of dangerous conflicts of interest.
“They're actually adding their own proprietary strategies alongside external, third-party managers,” Mr. Gottlieb said. “You can see the conflict of hiring and firing yourself.”
