How to Invest in an Alternative Fund

As equity prices move higher, deposit rates hover near zero and bonds remain expensive, investors are increasingly struggling to find attractive investment opportunities in traditional assets. It is therefore unsurprising that alternative UCITS funds have been one of the most popular destinations for European investors’ capital in 2016 with €21 billion flowing into funds in these categories in the first three quarters of the year.

While it has become the standard practice among investors to lump these funds together as a single group, alternative UCITS funds represent a bewildering array of strategies, demonstrated by the fact that Morningstar currently tracks 20 alternative categories across Europe.

Despite the variety of options available to investors, we have witnessed a high degree of concentration in the alternatives space at both the strategy and fund level with almost 50% of net capital flows being directed towards multi-asset absolute return funds since the beginning of 2014.

As these funds do not sit well within a typical asset allocation template, their popularity appears driven by a focus on achieving reliable positive returns rather than gaining particular asset or strategy exposure. This approach can result in too great a focus on recent past performance, leading to poor outcomes for investors as they buy and sell at the wrong time. Evidence of this is provided by Morningstar’s ‘behaviour gap’ research which shows that the return of the average investor in an alternatives fund has lagged the headline return of the fund by 58 basis points per annum over the last five years.

Several high profile and highly regarded funds struggled to deliver a positive return in 2016, with the most obvious example being Standard Life Global Absolute Return Strategies. Other examples include JP Morgan Global Macro Opportunities and Aviva Investors Multi Strategy Target Return.

Currency volatility was a key driver of returns last year, as shown by the poor performance of Henderson UK Absolute Return which has suffered from the fall in sterling. The impact of currency was also evident in the performance of Legg Mason WA Macro Opportunities bond fund.

As investors, we can draw on three key guidelines when considering alternative funds. First, we must have a clear understanding of why we own an alternative UCITS fund. Second, having selected an appropriate fund, remain focused on the long term. Finally, be aware of the unwanted exposures that can have a significant impact on the success of the strategy.