Morningstar - Summer 2019 - 13

Dispatches

Judgment Day
Alternative investments
burst onto the scene,
and then disappointed.

IVORY TOWERS

John Rekenthaler

Retail alternative-investment funds, practically
speaking, are 10 years old. Alternatives have long
been in institutional portfolios, but they
attracted little attention from retail buyers before
the 2008 financial crash. After the disaster,
however, the people craved protection, and the
fund companies responded. Launching a
spate of alternatives funds, they marketed the
strategies hard, gathering much of the mutual
fund industry's headlines. Hundreds of
alternatives funds were launched over the next
several years. Exchange-traded funds followed
suit, with offerings that ranged from staid to
highly speculative.
The timing was poor. With one notable exception
(more on that later), equities have since
pounded all rivals. For stock-heavy investors,
alternative investments have come in two flavors:
1) thoroughly useless and 2) mostly useless.

calendar years when stocks faltered: 2011, 2015, and
2018. The index barely broke even during the first
two of those years and lost 4.4% during the
third. Those are the sorts of years when investors
expect alternative investments to compensate.
5 Multicurrency

10-year annualized return: 0%
1 for 3 against the S&P 500
There are three flavors of currency funds. Leveraged
currency funds are for speculation. Single-currency
funds are unleveraged and serve as substitutes
for the foreign-exchange markets. Multicurrency
funds are also unleveraged. Being more stable
than single-currency funds, they are relatively painless devices for diversifying away from U.S. stock
(and bond) market risk.

Unfortunately, they have also been profitless.
Multicurrency funds delivered on their hope of low
volatility. Over the decade, the category's
worst calendar-year loss was just over 3%. Alas,
the same was true of its best calendar-year
gain. Multicurrency funds didn't lose much money,
but they didn't make any either. Might as well
have stashed your cash under a mattress.
Their performance, at least in nominal terms,
will improve when global interest rates
rise. Whether they will turn a profit after inflation
is less certain. One thing is for sure: With such
low expected total returns, multicurrency
funds had better be cheap. Even more than most,
these funds cannot overcome steep expenses.
4 Market Neutral

The problem is not just that the insurance was
sold after the fire-a customary practice
in investment management-but also that many
of the alternatives have been flat-out losers.
Even if U.S. stocks hadn't compounded by 13%
annually during the decade of 2009 through
2018, those funds would have been poor choices.
Thoroughly Useless
Following are the five poorest alternative
Morningstar Categories since 2009, in descending
order from worse to worst. For each category,
I provide the trailing 10-year average annualized
return, along with the number of times that
the category beat the S&P 500 during the three

category one notch lower because, unlike with the
aforementioned group, I see no hope for marketneutral funds. Multicurrency funds can fare well if
global fixed income thrives or if the U.S. dollar
suffers. The expected return for market-neutral
funds, on the other hand, is perpetually the Treasury
bill rate minus fund expenses. That is the
category's math, and it is not a pleasant equation.
3 Managed Futures

10-year annualized return: - 1.6%
0 for 3 against the S&P 500
What a disappointment. Managed-futures funds
were the 2008 success, notching a 5% gain
even as all stock funds, all lower-credit bond funds,
and even many alternatives funds cratered.
(The average hedge fund, for example, dropped
18% for the year.) The reason cited was
that their performance was not related to their
underlying holdings. It matters not if
they held stock, bond, currency, or commodities
futures, nor if those contracts rose or fell.
Managed-futures funds profit from anticipating
price movements.

The story sounded convincing, particularly when
accompanied by that 2008 gain. It no longer
carries much credence. Not only have managedfutures funds fared badly overall, losing
money for the decade, but when they were most
needed, they shirked the cause. They declined
during the S&P 500's two drab years, then
dropped even more than the index in 2018. They
didn't prevent the fire; they stoked it.
They may behave better during the next downturn.
The strength of managed-futures funds is
that they are truly unpredictable. Their positions
change with the trends, as do their relative
and absolute performances. Against that must
be weighed the reality that, in aggregate
and after their funds' expenses have been paid,
the group's portfolio managers have been
dart-throwing monkeys. Sometimes up, sometimes
down, eventually landing (before costs)
somewhere near zero.

10-year annualized return: 0%
1 for 3 against the S&P 500
If you swapped the calendar-year returns for the
market-neutral category with those of multicurrency funds, nobody would know the difference.
As with the multicurrency group, marketneutral funds gently fluctuated around a mean
of zero. (Perhaps they should be called "returnneutral" funds.) So gently that the category
never gained nor lost as much as 3% in any year.
One needs to pinch the funds to ensure that
they are alive.

2 Energy

Although the performance was identical to
multicurrency funds, I placed the market-neutral

10-year annualized return: 0.5% for equity energy;
- 9.1% for commodities energy
0 for 3 against the S&P 500

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Morningstar - Summer 2019

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