Morningstar Advisor - April/May 2012 - (Page 7)

Letter From the Editor Withstanding the Flood The last time we focused on alternative investing—in the December/January 2010 issue—we delved into what alternatives could offer a traditional stock/bond portfolio. We argued back then that skillfully applied alternatives can reduce risk and add diversification. We also said that they were easier to access, more liquid, and cheaper than ever before. Since then, assets flowing into alternative strategies have exploded as the industry has continued to make alternative strategies accessible to a greater array of investors. Fund companies have rushed to meet the post-crisis demand from investors looking for new ways to protect their capital or to earn steady positive returns. Today, it seems that the debate is no longer over whether or not advisors should include alternatives in clients’ portfolios. That is a given. The question today is, what is the best way to do it? This is the angle that we scrutinize in this issue. How should advisors respond as this whole new world of alternative investing becomes easier to enter? Should they alter their investment strategy to include more alternatives, or are most of these products flashes in the pan, doomed to flame out as they build longer histories that reveal that they didn’t perform as advertised? Michael Coop, who is head of alternative investments for Ibbotson Associates Australia, argues that advisors need to reconsider the standard answer to the often-asked question of how much should be allocated to alternatives (“How Much Is Enough?, Page 38). The old 10% allocation principle no longer applies, Coop says, because it was based on investing in hedge funds. With their liquidity restrictions, unregistered legal structures, and other risks, they were only suitable for a select group of high-net-worth investors and a small part of their portfolios. Today, the world is different. Alternative strategies come in a broad range of highly liquid, transparent vehicles that eliminate a lot of reasons why advisors might limit exposure to them. Therefore, advisors should base the allocation decision on more-fundamental reasons that are aligned with clients’ investment goals. Exchange-traded funds researcher Paul Justice tells the story of what happens when an esoteric investment is produced and packaged for the masses and then becomes the ETN version of an overnight sensation (“The Fear Bubble,” Page 42). To Justice, the fact that investors are rushing into short-term products—one ETN had to stop selling shares— that track the volatility index (VIX, the “fear index”) is indicative of some large issues—the biggest of which is that it is highly likely that these investors have misplayed their hand. Terry Tian, an alternatives analyst, then looks at the problems with absolute-return funds (“Why Absolute Return Funds Fail to Deliver,” Page 46). Many of these funds contain crucial flaws in their strategies, Tian says, which is why they have performed so poorly. And Tian doesn’t expect that all the investors who continue to pour new money into absolute return funds will experience anything differently. Finally, analyst Josh Charney profiles a talented long-short manager (“Undiscovered in Plain Sight,” Page 56). Michael Aronstein takes a different tack in running Marketfield Fund MFLDX than do other long-short managers, and he has what most alternative managers lack: a proven track record. Thank you for reading this issue. If you have any feedback, please let me know via Twitter. Jerry Kerns Follow Jerry on Twitter @ jerrykerns MorningstarAdvisor.com 7 http://www.MorningstarAdvisor.com

Table of Contents for the Digital Edition of Morningstar Advisor - April/May 2012

Morningstar Advisor - April/May 2012
Contents
Contributors
Letter From the Editor
We’re Too Smart
How Do You Use Alternatives?
Taking the Lead
How to Find Economic Moats
The Beauty of Currencies
No Clarity on Bonds
Four Picks for the Present
Investment Briefs
Performance Chasing, Evaluated
Technology’s Slim Pickings
How Much Is Enough?
The Fear Bubble
Three Traits of a Successful Long-Short Equity Manager
Why Absolute-Return Funds Fail to Deliver
An Economist’s Response to Crises
Undiscovered in Plain Sight
Untangling ETF Tax- Efficiency Myths
Central Banks Driving the Gold Rush
U.S. Industrials Could Add Some Magic to Europe-Weary Portfolios
No-Hesitation Allocation Funds
Our Favorite Mutual Funds
50 Most Popular ETFs
Undervalued Stocks With Wide Moats
The Greatest Story Ever Told

Morningstar Advisor - April/May 2012