Home' Trinidad and Tobago Guardian : September 13th 2015 Contents SBG10 STOCKS
SUNDAY BUSINESS GUARDIAN www.guardian.co.tt SEPTEMBER 13 • 2015
Hedge funds aren't just for the one
per cent. The mutual-fund indus-
try wants average investors to get
into its own version of hedge
funds, saying they can offer pro-
tection when the stock market is
tumbling. Kind of like it has been doing the last
The industry's push has helped draw more than
$10 billion in investment to these "hedge funds for
the masses" over the last year, and they're now in
the midst of a stress test. These funds, also called
liquid alternative funds, are supposed to deftly
maneuver rocky markets thanks to the more com-
plicated strategies they use. So, did they do that
this past month, when the Standard & Poor's 500
index had its first correction since 2011?
Yes, depending on your expectations. Alternative
funds lost money, but not as much as traditional
stock funds. That cushioned blow may be attractive
to investors looking for a steadier ride than stocks.
But it's important to keep in mind that these funds
come with their own risks and drawbacks, with a
high price tag chief among them.
Here's a look at what liquid alternative funds do
and how they've performed.
What they are:
Hedge funds have long been open only to big
institutional investors, such as pension funds and
endowments, and wealthy families. Deep-pocketed
investors have historically bought into hedge funds
because of the different trading strategies they use.
Instead of simply looking for a stock to rise in
price, for example, hedge funds also make money
from falling stocks by selling them short. In such
trades, they borrow shares, sell them and buy them
back later at a lower price.
Other hedge funds buy bonds of companies in
or expected to soon enter bankruptcy, which tra-
ditional mutual funds avoid. Hedge funds also scour
the commodity, foreign-currency and other global
markets in search of opportunities.
The mutual-fund industry has taken many of
these strategies and packaged them in funds targeting
average investors, requiring as little as $1,000 to
Such funds can go by many names depending
on which strategies they use. Long-short funds,
for example, sell some stocks short and buy others
on expectations they'll rise. Multi-alternative funds
have a mix of different hedge-fund strategies.
What they're supposed to do:
Alternative funds hope to make a portfolio more
diverse, by complementing traditional stock and
bond funds, and helping to steady performance.
"We're aiming for returns that are between fixed
income and stocks," says Ken LaPlace. He's a man-
aging director at Rock Creek Group and helps run
the Wells Fargo Advantage Alternative Strategies
Traditionally, investors worried about the poten-
tially big swings in the stock market turned to
bonds to steady their portfolios. High-quality bonds
returned 5.2 per cent in 2008, for example, when
the financial crisis dragged the S&P 500 to a 37
per cent loss.
But a decades-long drop in yields means bonds
offer less income than before, muting expectations
for future returns. "Fixed income is not going to
make a return for the next 10 years that it did for
the last 10 years," LaPlace says, "and people are
looking for an alternative to that."
His fund has made money this year despite all
the market's volatility, but LaPlace cautions that
his and other alternative funds aren't infallible.
Many alternative funds aim just to give a smoother
ride than the stock market, not to make money in
every type of market.
How they've performed
The sell-off that hit global markets during August
hurt alternative funds too. Consider multi-alternative
funds, which attracted more dollars in the last year
than any other type of alternative fund. They lost
an average of 2.3 per cent in August, according to
Although that hurts, it's not as painful as the 6.1
per cent loss for the largest category of traditional
The trend has held during other down months
for stocks, which means hedge funds for the masses
have at least partially shielded their investors this
Multi-alternative funds are down an average of
1.6 per cent for the year through Wednesday. The
largest category of traditional stock funds has lost
more than triple that, 4.9 per cent.
Over the longer term, though, the comparison
isn't so attractive. While alternative funds can limit
losses during down markets, they also lag when
the market is rising. And stocks have been on a
nearly nonstop rise since bottoming in March 2009.
The average multi-alternative fund has returned
an annualised 3.1 per cent over the last five years,
well below the 12.9 per cent average for large-cap
blend stock funds.
Alternative mutual funds are cheap when com-
pared against hedge funds, but they're much more
expensive than traditional mutual funds. That means
managers have a higher hurdle to jump to get to
Many alternative mutual funds have expense
ratios above two per cent, which means they keep
$20 annually of every $1,000 invested in the fund
to pay expenses.
The biggest stock mutual fund by assets, Van-
guard's Total Stock Market Index fund, keeps
US$1.70 of every US$1,000 invested.
As an index fund, it has particularly low expenses,
but even funds run by stock pickers charge less.
Actively managed stock funds kept US$8.60 of
every US$1,000 invested last year, according to the
Investment Company Institute.
The recent proliferation of alternative mutual
funds also means that many are too young to have
a long track record. That can make it tough to feel
comfortable paying such high fees, particularly
when the trading strategies they use can be difficult
for lay investors to understand.
Hedge funds have a longer track record but have
been up and down as a group in recent years. An
index of hedge-fund performance fell by about half
as much as the S&P 500 in 2008, for example, but
it had weaker returns than both stock and bond
indexes last year, according to Hedge Fund Research.
Mutual funds offer advan-
tages over individual stocks,
including diversification and
convenience. Investing in only
a handful of stocks is risky
because the investor's port-
folio is severely affected when
one of those stocks declines
in price. Mutual funds mit-
igate this risk by holding a
large number of stocks; when
the value of a single stock
drops, it has a smaller effect
on the value of the diversified
For example, suppose a
person owns 10 shares each
of two stocks, with each stock
valued at $100. If the price of
one of the stocks falls by 25
per cent, the value of the
portfolio declines from $2,000
to $1,750, a drop of 12.5 per
cent. If instead the portfolio
consists of one share each of
20 stocks, each valued at
$100, then a decline of 25 per
cent in the price of one stock
brings the value of the port-
folio from $2,000 to $1,975.
This is a decline by only
1.25 per cent in the value of
Mutual funds vs stocks
In addition, investing in
mutual funds is more con-
venient than investing in indi-
vidual stocks because the
manager of the fund research-
es stocks and decides which
ones to purchase. An investor
buying individual stocks has
to make these decisions for
However, the downside of
this convenience is a mutual
fund manager is paid a fee,
which reduces the amount
investors can earn from the
While mutual funds are
diversified and convenient,
whether investing in them is
an ideal way to maximise
returns is a matter of debate
among economists. Those
who support the efficient
market hypothesis (EMH)
believe investors who buy
individual stocks are generally
unable to achieve returns as
high as the returns of the
market as a whole.
Thus, they recommend
people invest in index funds,
which are mutual funds that
track a market index and gen-
erally have low expense ratios.
Other economists dispute this
hypothesis and argue that
buying individual stocks has
the potential for higher returns
than mutual funds.
Hedge funds for the
masses get a stress test
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