Alts Democratized - Rabe Jessica Lynn

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ETFs. Both individual investors and investment advisors should note that certain leveraged products may rapidly lose value and are not suitable for all investors.

      Legal Disclosures

      One of the authors of this book, Robert J. Martorana, CFA, owns a registered investment advisory firm, Right Blend Investing, LLC, in the state of New Jersey. This content shall in no way be construed or interpreted as a solicitation to sell or offer to sell investment advisory services. This is not a complete discussion of the information needed to make a decision to open an account with Right Blend Investing, LLC. There are always risks in making investments, including the investment strategies described.

      Right Blend Investing, LLC, may have long positions in the ETFs and mutual funds described, and these positions may change without notice. Mr. Martorana believes that the position sizes at his firm are too small to have a material impact on any fund described in the book.

      Guide to Chapters 3 through 13

      Chapters 3 through 13 review each of the 11 Lipper classifications in detail. This analysis forms the core of this book, and the following describes each of the subsections in these chapters. We briefly explain why we used certain data, and some of the pros and cons of our choices.

      The authors thank Tom Roseen, Head of Research Services at Lipper, for providing the data used throughout this book.

      Synopsis

      We offer a synopsis at the beginning of each chapter that covers the highlights and summarizes the key takeaways. This material may overlap with the conclusion of the chapter. But the synopsis is meant as a summary, while the conclusion focuses more on how advisors would use funds, and it presumes that advisors have actually read the chapter.

      The synopses can be read as freestanding content, and the advisor should not have to read the entire chapter to get value. The synopses are written in general language, and may be particularly helpful when advisors are creating talking points for clients. If the client has follow-up questions, the advisor can be confident that the chapter explains the concepts in detail and offers a supporting rationale for the trends, themes, and investment conclusions.

      Definition

      We start with the definition of each Lipper classification, supplemented by a working definition derived from the fact sheets and disclosure documents of the most popular funds. These chapters assume a strict adherence to the Lipper classification system. So while we acknowledge that some funds and strategies may have fuzzy boundaries, we aim first and foremost to explain the funds that each Lipper classification includes.

      Total Net Assets and Net Flows

      This section examines the history of total assets in each classification and their development over the past 10 years. We evaluate trends in assets, net flows, fund launches, and fund closures. This analysis gives a sense of how investor interest in the classification has waxed and waned in light of market returns and the returns for the classification.

      This section also explores the depth and breadth of fund choices for investors. Are there many funds with a variety of strategies? Or is the classification relatively homogeneous, with different flavors of the same basic strategy?

      As part of this process, we note any blockbuster funds that dominate the Lipper classification. The dominance of blockbuster funds is critical to understand, since some funds comprise 50 percent or more of the assets and net flows in a classification. This may give a distorted impression of the trends in the classification, since the asset growth may be dominated by a single fund. It can seem that a certain strategy is growing rapidly, and is worthy of deep investigation. The truth may be that a certain fund is popular because of recent investment performance, and the popularity of the classification may rest on the success or failure of a single portfolio manager.

      Risk and Return

      We discuss the returns of each classification over the past year, three years, five years, and 10 years. Some classifications have a limited history, so the data are absent and there are blank spaces in some of the exhibits.

      Our analysis focuses on the overall level of returns and on the dispersion of returns, which may be wide or narrow depending on whether the classification is homogeneous or heterogeneous. We also note when returns tend to cluster around some type of benchmark, reflecting the underlying factor exposures. Some classifications have high beta and high correlations to an index, whereas others are driven by idiosyncratic risks and decisions by the portfolio manager.

      When we compare returns in the classification to the underlying factor exposure, we usually offer a comparison to the S&P 500. As a convenience, data on the S&P 500 appears as a table in each chapter, so the reader does not have to flip through the book to find out how the classification compared to the equity market under different market conditions.

      We also show measures of risk: Sharpe ratios, Sortino ratios, and maximum drawdowns. There are many measures of risk we could have used, but our experience with these funds showed that returns and drawdowns were generally the most useful. These offer a thumbnail guide to whether the funds are offering an attractive mix of risk and return, though we must offer a major cautionary note: The five-year data coincide with a bull market, and this makes nearly all alternative strategies look poor in comparison to equities. Unfortunately, many of these products have not existed for a complete cycle of bull and bear markets, so it is impossible to definitively say how they might perform in a crisis.

      Factor Exposures

      This section of each chapter is intended to help advisors understand what drives the risk and return of each Lipper alternative classification. Fund performance can often be explained by equity beta, credit risk, and other factors, and these help determine the role that each fund plays in an investor's portfolio.

      This book often refers to analysis by the research staff at Lipper, which has done extensive work on factor exposures. We discuss this in detail in Chapter 3, Absolute Return Funds, and this chapter is the best starting point for a detailed discussion of how factor exposures affect the risk/return profile of alternative mutual funds and ETFs. The authors wish to thank Andrew Clark, PhD, Manager of Alternative Investment Research, for his assistance in helping to understand and interpret Lipper's research in this area.

      Asset Allocation and Fund Selection

      This section helps the advisor understand the proper role of each fund in a portfolio. It starts with the factor exposures that drive the classification, and it uses these to determine a process for evaluating a fund's track record. We discuss how some funds have stood out from the crowd, and we assess the degree to which this might be explained by top-down factors. Each classification is driven by different factors, so we discuss how to evaluate the effectiveness of funds using different strategies.

      This book assumes that alternative funds have different roles in the portfolio: portfolio diversifier, equity complement, fixed income complement, directional bet, or hedging of tail risk. Chapter 18 on fund selection discusses these roles in detail. Chapter 15 discusses the process, and it assumes the same roles for alts in a portfolio.

      Top Ten Funds

      This section reviews the assets, net flows, and investment performance of the top ten funds in each classification. The authors chose to focus on the top ten funds by assets because we believe this is an objective standard that can be used across classifications.

      Each Lipper alternative classification is driven by different factors, and the funds play distinct roles in portfolios. This makes it difficult to use a quantitative ranking method that is both fair and comprehensive. It is difficult for a single book to discuss the complete range of alternative strategies using a single measure of risk and return. For example, if we had ranked funds based on returns we would have favored funds with high equity beta, while a ranking based on low max drawdowns would have favored funds with low equity beta.

      The downside to our approach is that we seem to be favoring the largest funds in each category. This was not our intent, and we encourage advisors to use their own due diligence and the processes described in this book to uncover hidden gems in each classification that

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