The Wall Street Journal has a piece out this morning on Hedge Fund performance and the success they?ve enjoyed in the first half of 2015. Stock-focused hedge funds in particular have done rather well, with average returns of 5% versus just 3.23% for the S&P 500.
With the median S&P 500 stock up just 2.2%, there has been a lot of room for stock pickers and active management to add some value. The distribution of returns have been fairly wide, with 146 stocks- roughly one out of every three- up double digits so far.
It?s good to see active management do well after a few rough years. If you?re an index advocate, you should be thrilled with what?s been happened in the first half of the year. After a monster three year stretch for U.S. stocks, consolidating these gains through time, rather than through a correction, is about as much as you can ask for.
Active Management Makes A Comeback
For now at least, human stock pickers are making a comeback against the overall market and rivals who just aim to clone its performance.
Through the end of April, U.S. stock mutual funds that are actively managed rose 2.25%, including dividends and expenses, according to research firm Morningstar Inc MORN, +0.40% Mutual funds that track various stock indexes were up 2.2% in the same period, while the S&P 500 gained 1.9%.
And nearly half of the mutual-fund managers who research U.S. stocks before they buy or sell, often holding on to investments for months or years, beat their benchmark through April, up from 21% for all of 2014.
The pendulum that swung hard towards passive management with the innovation of exchange-traded funds is finally swinging back towards active management. ETFs have disrupted portfolio design for institutional and retail investors since the 1990s, but mutual fund companies are striking back with concentrated alpha in the form of liquid alternatives. Liquid alts are experiencing a sustained period of rapid growth, and this may parallel the early days of ETFs.
Liquid alts are garnering significant new money flows. Total net assets of liquid alts rose by 130% over the past five years, totaling +$340 billion as of December 31, 2014, according to preliminary data from Lipper. Assets have grown sevenfold in 10 years. Goldman Sachs believes they are ?capable of producing a $2 trillion AUM opportunity? over the next 5-10 years?a threshold crossed by ETFs just last month.
Here is a breakdown of this burgeoning asset class:
• Liquid alternatives are hedge fund strategies in the form of Investment Company Act of 1940 wrappers, such as a mutual fund or exchange-traded fund. The definition of liquid alts continues to change and evolve as classifications of these funds are subject to various interpretations by data providers, and reclassifications occur frequently. Lipper, for example, splits liquid alt strategies into eleven classifications.
• Liquid alts can go long and short in equity, fixed income, currencies, commodities and derivatives instruments. These funds democratize alternatives by providing retail investors with access to hedge fund strategies that were previously limited to high net worth individuals and institutions through traditional hedge funds.
• Bear in mind that liquid alts have restrictions on leverage and liquidity that prevent them from entirely replicating hedge fund strategies. Consequently, performance is often diluted relative to traditional hedge funds.
• Nevertheless, liquid alts provide benefits compared to traditional hedge funds, including better investor protection and greater transparency. Liquid alts have disclosure requirements that afford these benefits. They also sport lower investment minimums and expense ratios, and can be more tax efficient as well.
What do liquid alts have to offer beyond the typical stock to bond mix?
Alternative mutual funds and ETFs are best used as complements?as opposed to substitutes?to a portfolio?s stock or bond exposures. This is an important distinction and one that should help rejuvenate interest in active management. ETFs capture beta efficiently and cheaply, and are thus well suited for the core of a portfolio. Conversely, liquid alts capture concentrated alpha in the satellite of a portfolio, which can greatly improve the risk/return profiles. Here are five roles that liquid alts can play in portfolios:
? Portfolio Diversifier: These strategies are uncorrelated to traditional asset classes, such as stocks, bonds, and real assets. Inclusion of these strategies can help mitigate portfolio volatility. For example, Alternative Managed Futures Funds use algorithmic volatility management and trend-following strategies that go long or short in derivatives, commodities, financial assets, and exchange rates. These funds have limited beta exposures to stocks and bonds, thereby improving the diversification profile of a portfolio. Managed futures grew in popularity after outperforming during the financial crisis. They often earn modest returns during bull markets, however, due to their low correlations to financial assets like stocks. Alternative Managed Futures Funds earned 9.56% in 2014 according to preliminary Lipper data.