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By Brooks Ritchey
(Sponsor Content)
Alternative investment funds are an exciting new strategy class that were previously unavailable to retail investors in Canada. Since they are new to the scene, many advisors and investors are interested, but don’t quite know where to begin. Since I have worked in the alternative investment space for years, I thought I could help explain how investors could benefit from these hedging strategies.
Demystifying Liquid Alternatives for investors
Some advisors feel that these strategies are too volatile or complicated to explain to their clients. We spend a lot of our time trying to explain that these are not complicated mysterious investments. The irony is that many alternative investments, liquid alternatives, especially with regulatory oversight, are about the same risk level as fixed-income products.
Others also worry about the fees on hedge funds, but they have come down a lot. Since I’ve been involved in the hedge fund industry, fees have come down from 2% management and 20% performance fees to 75 basis points management fees and no performance fees for some products.
How would you explain Liquid Alternatives to investors?
It’s an investment that has different characteristics than traditional equity and fixed income. Equity markets depend on the trend in economic growth and bonds depend on a different set of macroeconomic factors, but they’re both dependent on a trend. If you’re trying to find a strategy that’s looking for winners in the equity or in the bond market when the trends aren’t positive, you want to consider liquid alternatives.
Different strategies within liquid alternatives
Even though they have similar names, many hedged strategies and liquid alternatives are vastly different. When you buy an equity mutual fund or equity-focused ETF, you’re going to get a similar risk-return profile. Whereas I prefer to call hedge strategies a product class. There are liquid alternatives that are being launched that are single-strategy and others that are multi-strategy, sort of like a balanced fund.
Are alternatives getting falsely judged for being too risky?
I think this needs to be viewed within the context of a total portfolio. For example, in a standard 60/40 portfolio of stocks and bonds, when the stock market comes under stress the 40% helps protect the portfolio. But it feels like it’s a different environment more recently. What if going forward the bonds don’t protect your equities like they have in the past?
When rates are low the bonds can’t rally that much more unless they’re going to go below zero. So alternatives provide a third product class that is uncorrelated to bonds. When equities come under stress, some hedge strategies do have a little bit of pressure, but when bonds come under stress the head strategies tend to more than compensate on the upside in performance. They’re what we call a conditional diversifier.
A high-level overview of the Franklin K2 Liquid Alternative mutual fund
Our Franklin K2 Alternatives Fund is a mutual fund that uses a multi-strategy approach to help investors preserve their capital. The fund provides one stop diversification designed to have low correlation to traditional equity and fixed income investments. The objective of this type of investment is to help mitigate risk during different market conditions. Franklin’s K2 Advisors have 24-years of experience in the alternative investing space, but these types of funds were previously only available to institutional and high net-worth individuals.
Where should investors start?
I think investors should consider how alternative investments may fit into their overall portfolios today, especially if they are concerned about downside risk. They should ask their advisor to review the asset allocation of their current portfolio and then run a few scenarios where they have a 5%-10% allocation to an alternative strategy. Then they will be able to see how the strategy class can help reduce drawdowns and losses. In some cases, it might also help with performance much more than they expect.
Brooks Ritchey is a senior managing director and head of portfolio construction for Franklin K2 Advisors. He works with various teams to analyze market and macroeconomic conditions, determine asset allocation tilts, and manage absolute return, multi-asset, and risk overlay portfolios. He is also a member of the alternatives executive committee, Japan investment committee, and K2 Advisors guideline committee. Mr. Ritchey has successfully managed multi-asset mutual fund and hedge fund portfolios while located in New York and Paris, France during his employment with organizations including Steinhardt Partners, Citibank, Finch Asset Management, Paribas, AIG, and ING.
Brooks Ritchey’s comments, opinions and analyses are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy. All investments involve risks, including the possible loss of principal. Investments in foreign securities involve special risks including currency fluctuations, economic instability and political developments. Investments in emerging markets, of which frontier markets are a subset, involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are magnified in frontier markets. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, industries or sectors, or general market conditions.
