Morningstar Magazine - February/March 2018 - 35

EXHIBIT 2

EXHIBIT 3

EXHIBIT 4

Intra-Category Flexibility Just because
funds share similar strategies doesn't
mean they'll have the same
characteristics, as demonstrated by the
long-short equity category.

Differing Diversification These two
multialternative funds have
similar return goals and volatility levels
but very different correlations to
equity markets.

Drawdown Clues The style box displays
median max drawdowns by style
over three years. As volatility increases,
so does downside risk.

Long-Short Equity Funds

Correlation

Goldman Sachs Absolute Ret Trckr Instl
Correlation
AQR Multi-Strategy Alternative I

Correlation

1.0

1.0

1.0

-5.13
0.5

0.0

0.5

-0.5
1.00

-8.85

-14.67
0.0

0.0

-2.93
0.66

-14.46

0.5

-3.77

0.00
0.33
Relative Volatility

-8.01

-8.57

-15.19
-0.5

-0.5
0.00
0.33
Relative Volatility

0.66

1.00

0.00
0.33
Relative Volatility

0.66

1.00

Source: Morningstar Direct. Data as of 07/31/2017.

Source: Morningstar Direct. Data as of 07/31/2017.

Source: Morningstar Direct. Data as of 07/31/2017.

year period the fund had positive returns
when global equity markets were up
and when they were down. That doesn't mean
the fund had no risk or suffered no losses, but
its returns were largely independent of
the direction of global equities. For portfolio
construction purposes, AQR Multi-Strategy
Alternative shows it can add diversification by delivering returns from sources
besides equity exposure.

stock market, though. So, investors can use
the fund to lower the overall volatility of a portfolio
by swapping it for equity exposure, but they
should still expect the fund to largely follow the
path of the stock market. Of course, if lowering
portfolio volatility is the only goal, that can
be achieved more cheaply by adding additional
cash or fixed income to a portfolio. Investors must
consider whether the return potential of an
alternative fund with a high correlation to equities
outweighs the extra risk compared with
those alternatives.

To illustrate, EXHIB IT 4 shows the average
maximum drawdowns for each region
of the alternatives style box over the three years
ending in July. For comparison, the maximum
drawdown of the global equity index was 13.3%.

Goldman Sachs Absolute Return Tracker can
benefit a portfolio in a different way. As E X H I BI T 3
shows, the fund has a strong correlation to
equity markets of 0.9. The fund seeks to replicate
the return and risk profile of a broad universe
of hedge funds by identifying the factors driving
the group's returns. Because it is trying
to replicate hedge fund returns, it will only fully
hedge its portfolio against the equity market
if hedge funds are. The high correlation signals
that the direction of hedge fund returns is
being explained by whether equity markets rise or
fall. The fund's low relative volatility indicates
it's only going to move a fraction as much as the

Considering Volatility and Downside Risk

The alternatives style box not only facilitates
comparison of funds, but also gives
visual clues into a fund's downside risk. Given
the positive relationship between volatility
and downside capture, it stands to reason that as
relative volatility-that is, the x-axis of
the alternatives style box-increases, so too
does drawdown potential. Thus, as funds
are plotted from left to right across the
style box, the maximum drawdown potential
also increases.

It's apparent that the alternatives style box
can make relative risks and potential downside
easier to observe and evaluate.
Four Corners

To further show how alternatives strategies come
in many different varieties and diversification
benefits, we examine the funds that fall into the
corners of the alternatives style box.
Alternative Funds With High Correlation and
Low Relative Volatility
In the top left region of the alternatives style box,
we find funds that have a high correlation
to global equities (above 0.5 over the trailing three
years) and a low relative volatility (less than
33% the volatility of global stocks when measured
by monthly standard deviation over the trailing
three years). Here is the breakdown of funds

global.morningstar.com/Morningstarmagazine

35


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Table of Contents for the Digital Edition of Morningstar Magazine - February/March 2018

Contents
Morningstar Magazine - February/March 2018 - Cover1
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Morningstar Magazine - February/March 2018 - Contents
Morningstar Magazine - February/March 2018 - 4
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