Investment firms offer alternative strategies in mutual funds and exchange-traded funds
Article from Chicago Tribune
By Rachel Koning Beals, U.S. News & World Report
January 6, 2012
Fund managers find themselves increasingly challenged to provide investors growth and protection in today's volatile global markets. Some firms, which manage stock and bond mutual funds and exchange-traded funds, are taking cues from hedge funds and including more sophisticated investment strategies in their mix.
In turn, investors may find themselves sifting through a growing number of alternative products that use these hedge fund-favored combinations. One popular strategy called "long-short" involves taking long positions in stocks (or bonds) with the expectation that they will increase in value, and simultaneous short positions in stocks (or bonds) that are expected to decrease in value. Do such offerings fit into average investors' portfolios?
"It's not the kind of thing that's been well-proven in the investment universe, but there are obviously people out there trying to do it, in large part because there's a tremendous demand for it," says Eric Jacobson, analyst at Morningstar, in a video interview on his firm's site. There are now enough long/short bond funds to warrant a separate Morningstar category outside of the multisector category it previously used.
As always, investors must gauge their overall risk tolerance and financial goals and consider expenses and other factors, but the general rule is that alternative investment strategies should be used to complement traditional mutual funds and ETFs.
Taking a long position in a stock simply means buying it; if the stock increases in value, you will make money. On the other hand, taking a short position in a stock means borrowing a stock you don't own, then selling it in hopes that it declines in value, at which time you can buy it back at a lower price than you sold it for. You then return the borrowed shares.
In bull markets, long-short funds might lag their long-only counterparts. But during bear markets, these funds tend to have a competitive advantage. Managers might use futures, options or an inverse stock position for the tactical portion of the portfolio that provides the downside "protection."
Gauging direction
The democratization of the long/short strategy has led to specialized products that blend equities, bonds, commodities, real estate, cash and more.
The approach of Rob Stein, who runs the Astor Long/Short ETF Fund, allows him to diversify across noncorrelated asset classes and approach investing using broader themes, such as macroeconomic performance over company-specific risk.
"Currencies, energy, precious metals, health care, small cap ... our approach is about low correlation to stocks, decision-making based on economic fundamentals, reducing beta, or volatility," says Stein, founder of Astor Asset Management, now part of Knight Capital Group. The firm, whose clients are investment advisers, runs about $1.2 billion in portfolios solely using ETFs.
The long/short approach is sometimes known as absolute return, when cash and an inverse offset are used to potentially limit the downside. But it's a sometimes misleading name that really means "positive" return.
Some funds use options strategies, writing covered calls as an income source, for instance. One such fund is Bridgeway Managed Volatility (BRBPX). Others have a narrower stock-picking approach, such as Quaker Event Arbitrage (QEAAX), which primarily makes long and short bets on equities, but managers focus on stocks and bonds that are involved in corporate events, such as mergers and acquisitions, restructurings, spin-offs, liquidations and changes in management.
Long/short funds can do a lot of heavy lifting with the convenience of one fund, often covering a variety of sectors and regions. Managers can fold in higher-risk, higher-growth opportunities in emerging markets for noncorrelation. "Our new long/short fund is designed for investors who want broad exposure to debt opportunities around the world, but are also concerned with volatility and interest-rate risks," says J. Alan Reid, CEO of Forward Management, which recently added the Forward Global Credit Long/Short Fund (FGCRX) to its long/short fixed-income lineup.
Reid says the new fund has some bias toward emerging markets, given their generally higher economic growth rates, but typically invests broadly in at least 10 countries at any time. The strategy can also potentially hedge against sovereign defaults and extreme credit-market downturns. At least 40 percent of assets must be invested in issuers based outside the United States.
Unconstrained bonds
Related subcategories can add to investor confusion. One such group is known as unconstrained bond funds. "The idea, generally speaking, behind unconstrained bonds is to give the manager a tremendous amount of freedom," Morningstar's Jacobson says. "So he or she can take a lot of interest-rate risk if they feel that the market presents an opportunity, or to not only perhaps take no interest-rate risk, but even take negative risk, so to speak. In other words, shorting the market so much that if interest rates fall and most bond funds are gaining, a fund like this would go the other way and vice versa.
"The other part of most of their strategies is that they have a tremendous amount of flexibility in terms of sectors as well, both domestically and globally," he says. "So, they may have emerging-markets bonds. They may have nondollar developed-markets bonds, high-yield. Pretty much anything you could think of that's a normal place for a multisector fund to go these days, you can find it potentially in an unconstrained bond fund."
Morningstar provides a short list of funds in the category with tested management: Harbor Unconstrained Bond Inst (HAUBX); PIMCO Unconstrained Bond Inst (PFIUX); JPMorgan Strategic Income Opps A (JSOAX); Putnam Absolute Return 100 A (PARTX); and Putnam Absolute Return 300 A (PTRNX).
It's clear that a variety of investments can bring opportunity to today's complex investor needs. "We believe that investors today need a substantially expanded tool kit to cope with high volatility, economic uncertainty and generally lower returns," Forward's Reid says. "Long-only strategies certainly have their place, and we offer a variety of them. But in our view, if you limit yourself to the traditional style boxes and a long-only approach, it's much more difficult to manage risks and get ahead in the long run. We're convinced that a tilt toward alternative investing is the direction of the future."
But some fund trackers urge a go-slow approach and reasonable expectations. "It's safe to say, we haven't really seen a case to be made that you should be using them to replace any kind of core position," Morningstar's Jacobson says. "I think that's important, because I think a lot of the marketing is suggesting to people that that's really what they ought to be doing."
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