While alternative funds have grown in popularity, they have not lived up to their hype. Mutual funds composed of alternative investments have proliferated in recent years and brokerage firms have sold billions of dollars of them as a way to combat low returns and high volatility that have soured investors away from traditional stock and bond investments. There are reportedly 251 alternative-style mutual funds and 303 alternative exchange traded funds, according to Morningstar.
Morningstar reports that 73% of financial advisors allocate from 6% to 10% of their clients’ portfolios to alternative investment vehicles. Some are even advocating an allocation of 40% of a client’s portfolio to alternative investment vehicles.
Alternative investment funds are often marketed as “market-neutral” or long-short” funds that straddle and partake of both up and down markets.
Investors should be skeptical of such claims. Morningstar reported that 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, long-short funds lost an annualized 1.28% versus 0.9% for the S&P 500. They also missed out on stock market gains. When the S&P 500 rose 8.1% from January 1 to July 22, long-short funds rose on average just 1.25%.
With regard to market neutral funds, Morningstar reported that they gained an annualized 0.11% over the past three years and 0.44% over the past five years. While that is slightly better than the S&P 500’s performance, investors would still 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.
Alternative mutual funds share many characteristics of hedge funds. Like hedge funds, their cost structure is higher than most U. S. equity mutual funds, and they subject the investor to more risk. Some newer alternative funds hold assets such as currencies and futures contracts. Some newer long-short funds hold concentrated short positions, which subject the investor to unlimited losses if markets rise.
Investors should be very wary of alternative funds.
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