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The challenge of allocating to alternative funds

The challenge of allocating to alternative funds

One aspect of our multi-asset fund asset allocation that, historically, has taken up a lot of airtime during investment committee meetings is that of the ‘alternative’ sector, which can often be rather subjective in its interpretation and the subsequent merits about inclusion in the portfolios questioned.  

My own views are not necessarily representative of the wider MitonOptimal team, but allocating to ‘alternative’ funds comes with a large degree of outsourcing an element of control and asset allocation as few funds in this space follow any prescribed benchmark.

After some quite extensive analysis of the funds that make up the large part of this universe, it is apparent that few perform with the consistency that one desires.

Additionally, the returns being offered on a ‘risk versus return’ appraisal rarely stand out as exceptional.

Therefore, it is little surprise that we have purposefully reduced our allocation to this asset class (if it can truly be described as an asset class) and shaped our own ‘libor plus’ mini strategies.

Whether this is allocating more capital to bonds and equities on a 20/80 split, or simply buying short duration investment grade bonds, the results are both more predictable and delivered with a level of risk that is within budget - no excessive ‘gross exposures’ or derivative use to be observant of.

We acknowledge a sector average is simply the sum of the parts, and within the sector there will always be standout performers.

There are currently 120 constituent funds in the IA Targeted Absolute Return sector, with the best performance over three years being an exceptional return of 89.4 per cent (Polar Capital UK Absolute Equity), while the worst performance was negative 21 per cent (GAM Star Discretionary FX).

This displays the huge disparity of returns, and in turn, the difficulty in selecting the best or most appropriate alternative fund for one’s portfolio.

Analysing the performance of the sector over one, three, five and seven years also leaves us underwhelmed relative to other asset classes adopting similar or lower risk characteristics.

The sector has delivered 0.6 per cent, 4.7 per cent, 12.8 per cent and 17.9 per cent over the observed time periods (to 30 June 2018), while a basket of short duration bonds, represented by the iShares £ Corporate Bond 0-5yr ETF, which has an effective duration of 2.7 years, has delivered 0.6 per cent, 7.1 per cent, 15.1 per cent and 26.5 per cent.

In isolation, this performance data carries limited vindication, but what adds more colour is the fact over three of the four time periods the level of volatility has also been lower using short duration bonds - the exception being the 7 year data. However, the outperformance justified the additional volatility.

We must also recognise the number of funds within the sector for this entire sample period is somewhat different to the make-up today.

Finally, observing the five largest funds in the sector by assets under management (a remarkable total of £61.2bn), four have made a loss in the past 12 months and two have made a loss in the last three years (to 30 June 2018), despite being managed by some of the best resourced teams money can buy.