Watching institutional investors achieve big gains in alternative investments has whet retail demand for mutual funds that incorporate alternative strategies.
Watching institutional investors achieve big gains in alternative investments has whet retail demand for mutual funds that incorporate alternative strategies.
This desire has fueled an interest in absolute-return funds, which have gained assets in the past couple of years.
Absolute-return funds aim to meet a target return, such as generating a 3% annual gain after inflation that isn't compared with a benchmark.
"Some have garnered healthy assets, but some have also lost them, in the last six months," said Jeff Tjornehoj, senior research analyst at New York-based Lipper Inc.
"Some will make shorting a common practice, while others will short when it's necessary," he said. "Others are using non-correlated assets like real estate or commodities."
There are risks with different investment vehicles.
"If a couple of investors get shaky feet about recent performance and bail out, they can set off a chain reaction," Mr. Tjornehoj said. "If they were trying to get an absolute return through longer-term vehicles, when people bail on the fund, they may have to redeem them well before they intended."
MEASURING RISK
Counterparty risk is assessed at the MFS Diversified Target Return Fund (DVRAX), which uses swaps as one of several vehicles in a derivative overlay, according to portfolio manager Joseph Flaherty. "In the area of swaps, we are not only managing the market risk but also the counterparty risk," he said.
Although classified by Lipper as an absolute-return fund, the fund is defined by Chicago fund tracker Morningstar Inc. as long-short.
The objective of the fund, which MFS Investment Management of Boston launched in the fall of 2007, is to deliver a target return that exceeds the rate of inflation over a full market cycle by 5 percentage points.
In addition to an "alpha engine" investing in stocks, MFS hired UBS Global Asset Management (Americas) Inc. of Chicago to manage a derivative overlay, which involves using futures, swaps and currency forwards as a hedge against risk, Mr. Flaherty said.
"The fund has half of the volatility of the equity markets," he said.
"It's not highly correlated. It's more absolute-return-focused and not tied to a benchmark," Mr. Flaherty said. "We are not dependent on the direction of the market and don't rely on a positive market to have a positive return."
Still, Mr. Flaherty said, investors should limit alternative investments to 10% to 20% of a portfolio.
Mellon Capital Management Corp. of San Francisco has managed absolute-return strategies for institutional clients since the 1990s. In 2007, The Bank of New York Mellon Corp.'s mutual fund unit introduced the Dreyfus Premier Global Ab-solute Return Fund (DGPAX). It also introduced to retail investors a similar world allocation fund called Dreyfus Global Alpha Fund (AVGAX).
The absolute-return fund has a return objective of 7.5%. The global-alpha fund has a hybrid benchmark that is a blend of 60% stocks and 40% bonds. Its goal is 5 percentage points over its benchmark. Both funds use derivatives such as futures, options and currency forwards, and long-short strategies for risk control, said Helen Potter, portfolio manager of the funds, and managing director and head of the asset allocation management team at Mellon Capital.
"There has been a big push into alternatives," she said. "Now it's available for retail investors. This is the stuff we have done for big institutions and pension plans for many years."
The derivatives used in the global-alpha strategy derive value from an underlying cash product, Ms. Potter wrote in an e-mail. "They are among the most liquid and transparent derivatives," she wrote. In addition, counterparty risk is screened and monitored. "To limit counterparty risk, we never set the expiration for our forward contracts out greater than three months," Ms. Potter wrote.
"I think alternative investments have a place in portfolios today," said Bill Carter, founder of Carter Advisory Services Inc. of Dallas, which has $800 million in assets under advisement. "But to get into them, you need to understand the risk and fully research it."
RESERVING JUDGMENT
Although Marjorie Determan is a self-described fan of absolute-return funds, the Nevada City, Calif.-based adviser is reserving judgment on funds using more-complex alternative strategies.
"I'm sitting on the sidelines and waiting for some three-year numbers to see what they are going to accomplish," said Ms. Determan, owner of Financial Strategies of Northern California of Nevada City, which has $60 million in assets under management. "I think this is a great test for them right now given the market environment."
Ms. Determan uses absolute-return funds, however, in 15% to 20% of a portfolio. "Absolute-return funds are good tools for smoothing volatility," she said.
Some advisers do not use them.
"I think today there is a lot of interest in these kinds of things because the market has been more volatile and down," said Joseph Alexopolous, principal of Aequitas Wealth Management LLC of Los Angeles, which has $18 million in assets under management. "But don't put money in the stock market unless you can afford to lose it periodically. What you are trying to hedge, you are losing in the long run."
"Exposure to new asset classes is good as long as expenses are kept low to moderate," Mr. Tjornehoj said.
E-mail Sue Asci at sasci@investmentnews.com.
