Morningstar Advisor - December 2012/January 2013 - (Page 65)

$10 million, $100 million, and $20 million of inflows over those three months, respectively. The fund’s Investor Return will be the constant monthly rate of return that makes the beginning assets equal to the ending assets with all monthly flows accounted for. The result will be a 2.9% loss over the three-month period, a far cry from the 5.6% total return. Our Findings for Alternative Funds Exhibit 1 Investor Returns for Alternative Mutual Funds Compared With Traditional Mutual Funds Return Gap (Annualized Percentage Points) Large-Cap Blend Intermediate-Term Bond Alternatives 2.5 2.0 1.5 1.0 0.5 1-Year Gap 3-Year Gap 5-Year Gap 10-Year Gap We examined funds in six of the seven alternative mutual fund categories. The small asset bases and the leveraged nature of bear-market funds make Investor Returns highly sensitive to asset flows. The gaps between their total returns and Investor Returns are off-the-chart outliers when compared with other alternative categories. We then calculated Investor Returns on funds over one-, three-, five-, and 10-year periods (as of Sept. 30), based on monthly returns for the oldest share classes of each fund in each category. We equally weighted the returns of each fund in a category to reach category averages. A positive return gap in a fund indicates that Investor Return is worse than total return; a negative gap suggests that investors made more than the fund’s total return over a particular period of time. Worse Investor Returns Exhibit 2 Investor Returns for Alternative Categories Currency Return Gap (Annualized Percentage Points) Market Neutral Long-Short Equity Multialternatives Managed Futures Nontraditional Bond 4.0 3.0 2.0 1.0 1-Year Gap 3-Year Gap 5-Year Gap 10-Year Gap We selected large blend and intermediateterm bonds to represent traditional stock and bond categories, respectively. We found that alternative fund investors behaved roughly the same as traditional bond fund investors over the one- and three-year periods. Over a longer timeframe, however, alternative investors fell behind. Over the past 10 years, the gap between total return and Investor Return for alternative funds increased to 2.43 percentage points annualized, while the gaps for the large-blend and intermediate-term bond categories were 0.14 and 1.23 percentage points, respectively (Exhibit 1). Within the alternative categories, long-short equity and nontraditional bond funds exhibited the worst Investor Returns in most of the timeframes measured. Market-neutral funds had relatively narrow and consistent gaps (Exhibit 2). Our results show that alternative mutual funds have worse Investor Returns compared with traditional stock and bond funds most likely because alternative funds have much shorter histories marked by a very volatile market environment. Massive inflows to alternative funds occurred after the 2008 financial crisis, when the performance of many of these strategies lagged. Investors poured almost $90 billion into alternative mutual funds between 2009 and 2011, when total assets in these funds stood at only $34 billion at the end of 2008. Flows into traditional stock and bond funds have been smoother and less reactive to category performance over the long run. Link With Volatility Our studies seem to indicate that one important determinant factor of Investor Returns is a fund’s volatility. We ranked all alternative funds based on their monthly standard deviation in descending order and divided them into four quartiles. Funds in the first quartile have the highest standard deviation, and funds in the fourth quartile have the lowest. Funds in the most volatile quartile almost always have the largest Investor Return gaps1 (Exhibit 3). MorningstarAdvisor.com 65 http://www.MorningstarAdvisor.com

Table of Contents for the Digital Edition of Morningstar Advisor - December 2012/January 2013

Morningstar Advisor - December2012/January 2013
Contents
Contributors
Letter From the Editor
What Stands Between Me and Stupid
Why Do You Use Dynamic Funds of Funds?
Serving Clients and Community
How to Pick an ETF Managed Portfolio Strategy
Tactical View of Risk
Investments á la Carte
Investment Briefs
Unbundling ETF Managed Portfolios
Risks Loom Over Telecom Industry
Outsourcing Asset Allocation
ETF Managed Portfolios on the Rise
Age-Based Options Take Over 529 Industry
How the Landscape for Advisors Is Changing
Mark Egan Embraces Volatility
Alpha, Beta, and Now … Gamma
Performance Gaps
Gains in Momentum
Companies Where Management Teams Add Value
Our Favorite Mutual Funds
50 Most-Popular Equity ETFs
Undervalued Stocks With Wide Moats
The Once and Future King

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