Читать книгу Alts Democratized - Rabe Jessica Lynn - Страница 7

The allure of hedge funds has enthralled investors since the pioneering work of Alfred Winslow Jones in 1949. Talented money managers have traditionally emerged from the incubator of large institutions prior to gleaning capital from family and friends as a means to launch their own hedge funds, often in the Big Apple. Distant from the Securities and Exchange Commission (SEC) and largely unregulated, hedge fund managers have often employed obscure and complex strategies to generate alpha (excess return or outperformance relative to their benchmarks), and this has allowed the notoriously lucrative “2 and 20 percent” fee structure. Hedge funds are also notorious for their illiquidity, lack of transparency, and high investment minimums. Nevertheless, hedge funds remain an exclusive club that attracts high-net-worth and institutional clients, while being out of reach for the average investor.

That is, until these sophisticated strategies were democratized in the form of Investment Company Act of 1940 ('40 Act) wrappers (i.e., mutual funds), thereby giving hedge fund managers access to the retail market. For some top-tier managers, small accounts are time-consuming and burdensome, but other managers recognize the opportunity to expand their footprints through retail distribution of their hedge fund strategies. Their efforts are paying off, and this book will explore the rapid growth of the liquid alts space.

Why do we say “democratized”? Because liquid alts have extended access to hedge fund strategies to investors on Main Street. Mutual funds have used leverage and short selling for decades, and these are the same strategies that trailblazer Alfred Winslow Jones used in the first pooled investment vehicle that focused on alternative investment strategies. But recent product innovation has propelled the growth of liquid alts to new heights as these products reach a much broader base of investors. The proliferation of products peaked in the middle of the preceding decade with the launch of dozens of alternative mutual funds. These new products are similar to traditional hedge funds in their use of leverage and the ability to go both long and short in equity, fixed income, currencies, commodities, and derivative instruments. Thus, '40 Act alts democratize access by empowering both high-net-worth and retail investors with sophisticated investment strategies.

In addition to expanding access, liquid alts offer benefits that differ in key ways from traditional hedge funds. The '40 Act products have disclosure requirements that help protect investors and that make the products more transparent. Liquid alts also have lower investment minimums, greater tax efficiency, and lower expense ratios. Thus, these funds offer diversification benefits and potential alpha that had been available only to the upper echelons of the income scale by way of traditional hedge funds.

The democratization of hedge fund strategies starts with access to '40 Act products, but what value is this access if investors are unsure of how to use liquid alts effectively in traditional portfolios? In order for '40 Act liquid alts to truly penetrate the retail market, the education of liquid alts must also be democratized. This is especially challenging given the history of hedge funds, which have historically been abstruse strategies that do not always report underlying positions.

Many of the concepts required to use liquid alts are genuinely new to retail investors, and beyond the scope of traditional educational materials since the analysis of hedge fund strategies has been necessary only for institutional investors. These strategies are complex, and are often further obscured by hyperbole in the marketing materials. If advisors use liquid alts without a proper framework and proper management of expectations, investment results will suffer and clients will be disappointed.

This is where we come in. Our objective is to serve as your guides by arming you as the advisor with the analysis, tools, and, above all, the process that will enable you to incorporate liquid alts within portfolios to reach clients' goals. Liquid alts offer potential alpha and diversification through noncorrelation, thereby creating the potential to push client portfolios further out on the efficient frontier. Advisors' understanding of these products and the underlying strategies will help achieve a more optimal balance of risk and return. Equally important for advisors is the need to relay this information back to clients, so they will understand the underlying strategies and positions of their portfolios. This will help you as an advisor to manage expectations, which will enhance long-term performance as clients will be less apt to panic and bail out at a market trough, and advisors will be less likely to come under pressure from clients to unwind positions at fire-sale prices.

Given the right education, what if you could manage client portfolios like an endowment? Liquid alts act as a vehicle to get you one step closer. Endowments must generate sufficient returns to cover the annual withdrawal for university expenses, in addition to growing the asset base to protect the principal from inflation. They often attain high returns in excess of traditional equity and fixed income indexes. How do they achieve these superior returns? By using the endowment model – most notably at Yale University and Harvard University – which usually allocates a smaller portion of the portfolio to equities and fixed income, and a greater portion to nontraditional assets, such as hedge funds, private equity, venture capital, and real assets (including infrastructure and natural resources). These alternative assets require substantial minimum investments and are highly illiquid, but they can boost returns significantly.

Granted, the endowment model is more suitable for higher allocations to risky nontraditional assets due to its long investment time horizon afforded by institutions such as pensions and universities. Allocations with tilts of this nature would be imprudent for most clients. Consequently, we created a practical framework for the proper usage of liquid alts by modifying the endowment approach. We call this the Micro-Endowment Model (MEM). Throughout this book, we assign five roles to liquid alts depending on their factor exposures: equity complement, fixed income complement, portfolio diversifier, tactical hedge, and directional bet. These roles supplement the equity and fixed income exposures of a traditional portfolio, and, like the endowment model, include allocations to alternatives (hedge funds and private equity) and real assets, while leaving room for a little cash.

The MEM therefore sports an alternative tilt that is more reasonable for individual investors, providing the portfolio with potential for enhanced returns and alpha generation from a number of sources: diversification through noncorrelation, directional bets, hedging of tail risks, active management of credit and duration risks, and preservation of capital using nontraditional assets. The MEM may not be suitable for all clients, but we describe it as a tool that may help the portfolio construction process.

Bear in mind that the MEM assumes a core/satellite approach, which blends passive and active funds and helps separate beta from alpha. This process can enable customization by focusing the satellite of the portfolio on specific client needs. Meanwhile it limits costs by using passive funds in the core for beta exposure to equity, fixed income, real assets, and certain alternative assets. The customization facilitated by the core/satellite approach helps advisors adapt to the changes in portfolio construction that we outline in Figure 15.2: Rather than targeting a benchmark and sticking with a buy-and-hold strategy, many advisors now use both strategic and tactical approaches to meet client goals.

Another advantage of the core/satellite approach is its focus on cost-effective portfolio construction, which underscores a major headwind for liquid alts: high expense ratios. We acknowledge that fees should be a primary concern at the portfolio level since expenses are the only factor known with certainty in advance. However, an investor should not always make fees a primary concern at the product level, since a portfolio that combines alpha and beta will have a wide range of expense ratios.

To put these strategies, models, and approaches in perspective, the current macroeconomic environment is one in which investors are scouring the globe for yield as interest rates hover near zero, rising rates are on the horizon, inflation is inching toward the Federal Reserve's 2 percent target, and correlations are normalizing after converging during the financial crisis. These factors encourage investors to seek enhanced income, active management of credit and duration risks, hedging of tail risks, preservation of capital for those worried about inflation, and, most notably, diversification. Liquid alts help achieve these goals.

With that said, liquid alts are by no means ideal, and not all classifications are truly uncorrelated. Many strategies have high equity beta, and others do not comport to their mandates or to what the classification's name suggests. We help advisors sift through each classification as defined by Lipper by evaluating factor exposures and identifying the likely roles of funds within portfolios. But there are natural limits to applying any analytical framework that relies on abstract theoretical assumptions. It may make sense for investors who have a process that is quantitatively rigorous, has significant research resources, and is applied in a disciplined manner over time horizons measured in decades.

This approach may be feasible for institutions, but it is impractical for most individuals. Every client relationship must eventually address a wide variety of random life events that involve money. These include death, divorce, new jobs, retirement, medical issues, sale of the family business, and so on. Adapting to these events is part of what makes investment advice an art, and not a science. We believe that alts democratized can be a useful concept, and our framework aims to help you as the advisor achieve more tactical, customized, transparent, and cost-effective portfolios for your clients. But we leave the application in the hands of the advisor.

Overall, we view liquid alts as a source of psychological alpha: investments that mitigate the consequences of fear-driven and nonproductive asset reallocation that is often triggered by market volatility. Liquid alts provide a sense of security due to their uncorrelated characteristics, which in turn encourage discipline when it is needed most: during bear markets. If markets were rational, equities would be less volatile, and investors would not panic during crashes. In some ways, alternatives act as a form of insurance, and allow investors to take prudent risks with the equity allocations of their portfolios. Investors need stocks for long-term growth, but the volatility is difficult to live with.

Therefore, liquid alts provide a behavioral hedge that makes it easier for investors to tolerate market volatility and reach their long-term investment goals. An allocation to liquid alts enables advisors to hold a greater share of equities, and reduces bail-out risk during declines in the market, as long as clients understand the diversification benefits of alts. Likewise, advisors must also keep clients abreast of the tendency for liquid alts to lag during bull markets: Just as alts keep investors from bailing out of equities at the bottom, investors need to stick with liquid alts even when equities are reaching new highs.

Liquid alts, as a source of psychological alpha, help investors stay in the game.