Alternative funds, mutual funds that use hedge fund-type strategies but do not charge typical hedge fund performance fees of 20%, aren’t producing expected results. The attraction of alternative funds was the promise of growth with of downside protection as a result hedging strategies.
As a result, investors have placed billions of dollars into these alternative funds in recent years, as low returns on conventional investments along with high volatility have driven thousands of investors to try one or more of the myriad alternative investments created by Wall Street wizards. Like hedge funds, alternative fund managers have broad discretion to use futures, options and other derivative products, to go long or sell short, implement long-short straddles, and pursue other alternative strategies in their effort to achieve the perfect (but non-existent) investment: risk-free growth.
A recent Wall Street Journal article (“Do ‘Alternative’ Funds Deliver?”) found that the performance of alternative funds fell far short of their hype.
According to Morningstar, alternative long-short funds had an annualized loss of 1.17% over the past three years versus a 0.02% annualized gain for the S&P 500 stock index. Over the past five years, the long-short category lost an annualized 1.28% versus 0.9% for the S&P 500.
In addition to losing more, such alternative funds have also missed out on stock market gains. From January 1 to July 22, when the S&P 500 rose 8.1%, the average long-short fund rose just 1.25%, missing out on 15% of the broad market’s rise.
A different category of alternative funds, called market neutral funds that are designed to generate positive returns in both up and down markets, performed a little better. Over the past three years, this category gained an annualized 0.11% (only slightly better than the S&P 500’s 0.02% gain). Over the last five years, market neutral funds bested the S&P 500 by gaining an annualized 0.44% versus the S&P 500’s 0.9% decline. Still, investors would have been better off investing in Treasury bills, which gain an annualized 0.26% over the least three years, and 1.76% over the past five years.
As with their hedge fund cousins, alternative mutual funds have higher expenses ratios than U. S. equity mutual funds. They also carry much more risk.
Some of the newer entrants to the alternative funds field include much riskier currency and managed futures funds. In addition, some of the long-short funds are heavily or even 100% short, which can pay off handsomely if the markets continue to tank, but risk disastrous losses if markets rise.
As with many alternative investments, the term “hedge” can be a misnomer as funds use risky derivatives, concentrated positions and leverage in search of higher returns.
Page Perry is an Atlanta-based law firm with over 150 years collective experience representing investors in securities-related litigation and arbitration. While past results are not indicative of future success, Page Perry’s attorneys have recovered over $1,000,000 for clients on more than 45 occasions. The firm regularly represents investors in hedge funds and alternative funds. For further information, please contact us.