Strategies Have Failed – Part III. Fund of Mutual Funds
by the Curmudgeon with Victor Sperandeo
This is the third and final article which strongly makes the case that alternative investment strategies have failed. The first article was on hedge funds.
The second article covered liquid alternative mutual funds.
This final piece examines fund of funds/ETFs along with Victor’s thoughts on correlations and a rigged casino!
Expectations Not Met:
One would expect a fund of alternative/hedged mutual funds/ETFs would produce a positive total return since one or more seasoned experts (the fund managers) are evaluating, selecting and changing the mutual funds in their portfolio of funds/ETFs. A positive “absolute” return would certainly be expected during a time period where short term interest rates have been at or close to zero for an extended period of time since that makes many asset classes theoretically more attractive than the negligible return on cash.
Astonishingly, that’s not been the case for the open end (public) fund of funds/ETFs we’ve checked and analyzed. They all show negative total returns for 3 months, 6 months, YTD, and 12 months/one year. Only one fund of funds has a positive total return over the last 2 years (see CLSHX below).
Referring to the earlier referenced part II article on Failure of Liquid Alternatives, Morningstar recently wrote (free log in required):
“The average long-short equity fund had a negative alpha of 2% (relative to the S&P 500) annualized over the three-year period ended Aug. 31. That suggests the average long-short equity manager detracts value through stock-picking.”
We wonder if there are any alternative fund of funds that actually have positive alpha with respect to their respective benchmarks. How about a benchmark of cash + 3% which is what market neutral funds typically use? Not one fund of funds comes close to meeting that performance criteria!
Another Caveat: Fund of Fund Expenses are High:
Note that all fund of funds/ETFs have two layers of expenses-for the fund company that offers the fund of funds + the individual funds in the portfolio which is sometimes hidden and not contained in the prospectus. The sum of all the expenses can be as high as 3% or more!
However, that’s better than many private fund of hedge funds which have higher overall expenses plus management and incentive fees that are almost never deductible from an investors IRS tax return (disallowed under AMT and subject to 2% AGI threshold if not in AMT).
Fund of Alternative Funds Examined:
The following funds use other fund company’s alternative funds:
ALSOX/ALSNX - ASTON/Lake Partners LASSO Alternatives Fund (previously & still offered as the LASSO hedge fund of alternative mutual funds)
NCHPX - New Century Alternative Strategies Portfolio fund (fund of alternative mutual funds)
ACOPX - Alpha Opportunistic Alternatives Fund (seeks equity-like returns with lower volatility)
ACDEX - Alpha Defensive Alternatives Fund (seeks high single digit returns with downside protection)
TNMAX - Multi-Alternative Strategies Fund (new fund of funds launched this year)
NAVFX - Sector Rotation Fund (uses ETFs rather than open end mutual funds)
CLSHX1 - AdvisorOne CLS Shelter Fund (also uses ETFs, hedged equity and closed end funds)
Note 1. CLSHX has a positive 2 year total return, but negative return for 1 year and shorter time periods.
The following funds use their own brand of alternative mutual funds along with ETFs and/or institutional strategies not available to the retail investor:
PDPAX - Virtus Alternatives Diversifier Fund (uses Virtus mutual funds and unaffiliated ETFs)
IMUAX - Transamerica Multi-Manager Alt Strategy (uses Transamerica mutual funds)
VPGDX - Vanguard Managed Payout Fund (has 10.1% in Vanguard Alternative Strategies Fund, 7% in Vanguard Market Neutral Fund, 5.1% in Commodities)
PAUIX/PAUDX – PIMCO All Asset All Authority (has maintained a 16-20% short US stock position, but is heavily long emerging market local currencies, bonds and stocks).
Disclosure: The CURMUDGEON has been invested in PAUIX/PAUDX since 2003 to date and had all RIA clients in PAUIX when he was managing money. The fund is down almost 20% in the last year. The NAV chart is not a pretty picture over the past several years:
Despite their terrible performance, Morningstar reports that alternative mutual funds net sales were more than $800 million in August 2015. That’s not an insignificant sum, considering that these funds still make up less than 1.5% of open-end mutual fund assets. Compare those inflows to diversified domestic-stock funds, which had $69.7 billion in outflows for the year, including $9.2 billion in August alone!
Perhaps, the popularity of liquid alt funds and fund of funds reflects the turbulence many investors endured with traditional stock and bond portfolios during the financial crisis, as well as muted forward-looking return expectations for traditional asset classes.
In addition, unstable correlations across many asset classes have left investors with fewer reliable portfolio diversifiers. The sharp increase in correlations (see Victor’s comments below) has certainly been the case for the latter part of 2015 as well as during 2013’s “Taper Tantrum,” which left many investors concerned about the ability of fixed income allocations to diversify their portfolio’s equity risk.
The bottom line is that performance of liquid alts and fund of funds has been miserable, while fees are much higher than either indexed or active manager based mutual funds. Hence, it’s very difficult to justify an investment in most of those funds at this time.
As a result, we are stumped in finding good long term buy and hold, all weather funds that are flexible enough to earn positive total returns (that beat T-bills) during any type of market environment.
Victor’s Closing Comments:
The reason asset class correlation is a potential losing trap is that events can cause correlation with global equities to become 1.00 in any given time period. That defeats the purpose of asset allocation, especially on the downside when you need it most!
The reason for today’s losses across so many asset classes and alternative strategies is the casino has been rigged by central planning and the business cycle is turning down. In all of the Fed manipulations the end has to occur sometime, perhaps now?
The most brilliant economist of the Austrian school of Economics was Ludwig Von Mises2, whose famous quote of central banks printing of money should be put on every one’s desk:
"The final outcome of credit expansion is general impoverishment."
Note 2. I will be speaking at the 7th Annual Mises Celebration at 7:30pm on Sept 26th in San Jose, CA. Jeffrey Tucker's keynote speech at 8pm will be on "Why Mises Still Matters in the Digital Age."
Good luck and till next time…
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Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.
Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies. Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.
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