Morning Star Mainstreaming Alternative Investments December 2009

8/14/2019 Morning Star Mainstreaming Alternative Investments December 2009

http://slidepdf.com/reader/full/morning-star-mainstreaming-alternative-investments-december-2009 1/22

<#>

© 2006 Morningstar, Inc. All rights reserved.

Mainstreaming Alternative Investments

× Nadia Papagiannis, CFA

Alternative Investments Strategist

December 1, 2009



2

Morningstar’s Coverage of Alternative Investments

× Institutional database products:

× Morningstar® DirectSM

× Morningstar® Alternative Investment CenterSM

× 8000 hedge funds, including 3000 fund of funds.

× Alternative mutual funds, ETFs, closed end funds, andseparate accounts.

× 330 datapoints, including Form ADV and 13-F holdings.

× Proprietary Indexes:× 27 Morningstar Hedge Fund Indexes and 190 Morningstar

MSCI Hedge Fund Indexes.

× 5 Morningstar Commodity Indexes.



3

Morningstar’s Coverage of Alternative Investments (continued)

× Morningstar RatingsTM:

× Hedge funds with 38 months of data.

× Mutual funds and ETFs with 36 months of data.

× New Operational Risk Indicator for hedge funds.

× Alternative Investments Observer quarterly newsletter.



4

Flood of New Alternative Investments

× New “alternative” funds have flooded the US market place in the last decade, inboth mutual fund and ETF form.

× Morningstar tracks 346 such funds, 141 mutual funds and 205 ETFs.

New Alternative Funds

0

20

40

60

80

100

120

1 9 7 7

1 9 7 8

1 9 8 5

1 9 8 9

1 9 9 0

1 9 9 1

1 9 9 4

1 9 9 5

1 9 9 7

1 9 9 8

1 9 9 9

2 0 0 0

2 0 0 1

2 0 0 2

2 0 0 3

2 0 0 4

2 0 0 5

2 0 0 6

2 0 0 7

2 0 0 8

2 0 0 9

Number of New Alternative Funds



5

Investors Appetite for Alternative Mutual Funds

× Flows in to alternative mutual funds have grown rapidly in 2009, especially inthe Long-Short category.

US Alternative Mutual Fund Flows

-4,000

-2,000

0

2,000

4,000

6,000

8,000

10,000

12,000

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

YTD

$ m i l l i o n s

Bear Market Currency US Long-Short



6

Investors Appetite for Alternative Mutual Funds

× Long-Short mutual funds are also the fastest growing alternative category.

Long-Short Mutual Fund Launches

0

5

10

15

20

25

1 9 7 7

1 9 8 9

1 9 9 1

1 9 9 7

2 0 0 0

2 0 0 2

2 0 0 4

2 0 0 6

2 0 0 8

New Long-Short Mutual Funds



7

Morningstar’s Alternative Mutual Fund Categories

× Long-Short, Bear Market, and Currency:

× Long-Short funds use shorting, but remain net-long or neutralin exposure.

× Bear Market funds take a net-short equity exposure, and can

be leveraged.× Currency funds trade spot currency, forward or future

contracts, ETFs, or money market instruments.

× The Long-Short category exhibits the greatest diversity.



8

Breakdown of Long-Short Category

× Option/Buy-write strategies

× Gateway, Calamos Market Neutral, The Collar funds.

× Non-directional strategies

× Arbitrage strategies:

× Arbitrage, Merger, and AQR Diversified Arbitrage.

× Equity market neutral strategies:

× Highbridge Statistical Market Neutral, JP MorganMarket Neutral, TFS Market Neutral.



9

Breakdown of the Long-Short Category (continued)

× Long-short equity funds

× Directional shorts: Diamond Hill Long-Short.

× Hedgers: Hussman Strategic Growth.

× Credit strategies

× Forward Long/Short Credit Analysis.

× Commodity or diversified managed futures strategies

× Rydex/SGI Managed Futures Strategy, Direxion CommodityTrends Strategy.



10

Breakdown of the Long-Short Category (continued)

× Multi-Strategy

× Van Eck Multi-Manager Alternatives, Aston/Lake PartnersLasso Alternatives, Absolute Strategies.

× Absolute return is neither a category nor a way to distinguishinvestments.

× Alternative funds act differently based on asset class/instrumentsused and trading strategy.



11

Morningstar’s Definition of Alternative Investments

× Alternative Investments should provide:

× Positive risk-adjusted returns over time.

× Lower correlation to traditional stock and bond portfolios.

× How do investments meet this criteria?

× Investing in different asset classes/instruments.

× Shorting or hedging.

× What we do not consider alternative:

× Equities with commodity exposure.

× REITS.

× 130/30 strategies.

× Emerging market stocks or bonds.



12

Correlation of Various Investments to a 60/40 portfolio

× A 60/40 portfolio comprised of the I-shares S&P 500 Index and the BarclaysAggregate Bond ETF incepted in October 2003 and rebalanced quarterly.

1 2 3 4 5

1 60-40 Portfolio

2 Vanguard Precious Metals and Mining 0.71

3 Vanguard REIT Index Inst 0.78 0.56

4 S&P 500 130/30 Strategy TR 0.97 0.71 0.74

5 Vanguard Emerging Mkts Stock Idx 0.84 0.86 0.60 0.83

6 JPM EMBI Global Diversified TR USD 0.72 0.68 0.60 0.66 0.69

Date: 10/1/03-9/30/09 1.00 to 0.60 0.60 to 0.20



13

Drawdowns Relative to a 60/40 portfolio

Maximum Drawdown Oct. 2003 to Sep. 2009Max

Drawdown

# of

Periods Peak Date Valley Date

60-40 Portfolio -31.86 16.00 11/1/2007 2/28/2009

Vanguard Precious Metals and Mining -68.86 6.00 6/1/2008 11/30/2008

Vanguard REIT Index Inst -66.59 23.00 4/1/2007 2/28/2009

S&P 500 130/30 Strategy TR -47.56 16.00 11/1/2007 2/28/2009

Vanguard Emerging Mkts Stock Idx -62.70 16.00 11/1/2007 2/28/2009

JPM EMBI Global Diversified TR USD -21.81 5.00 6/1/2008 10/31/2008



14

Commodities as Alternative Investments

× Commodities are a trading strategy rather than an asset class or a“beta.”

× Investors access commodities primarily through exchange-traded futures contracts.

× Futures contracts have a net supply of zero, and therefore

there is no “market portfolio” as there is in stocks and bonds.× The S&P GSCI and the Dow Jones UBS indexes exhibited high

correlations to stocks and bonds in 2008.

×

Better “alternatives” to commodity investing:× Long-short commodity or diversified managed futures trading

strategies.

× An active approach using ETFs/ETNs.



15

No Such Thing as a Commodity Beta



16

How to Invest in Alternative Mutual Funds--Do Your Homework!

× Not all alternatives are createdequal.

× The average long-short mutualfund is highly correlated tostocks.

× Bear market funds show poorrisk-adjusted returns onaverage.

× Long/short commodity works,but the few funds that exist donot have long track records.

Correlations (monthly) Oct. 2003 to

Sep. 2009 1 2 3 4

1 60-40 Portfolio

2 US OE Bear Market -0.96

3 US OE Currency 0.31 -0.26

4 US OE Long-Short 0.91 -0.88 0.32

5 Morningstar Long/Short Commodity TR -0.24 0.20 0.04 -0.06

Sortino Ratio (monthly) Oct. 2003 to

Sep. 2009

60-40 Portfolio 0.24

US OE Bear Market -0.85

US OE Currency 0.45

US OE Long-Short -0.10

Morningstar Long/Short Commodity TR 0.96



17

Addition of Select Long-Short Mutual Funds to a 60-40 Portfolio

× Example of a 20% allocation to long-short hedged equity fund, market-neutral fund,and a managed futures fund.

× Both the returns and the downside deviations were improved in all three portfolios.

Inception

Date

Max

Drawdown

Sortino Ratio

Oct. 03 to

Sep. 09

Sortino Ratio

Apr. 07 to

Sep. 09

60-40 Portfolio 10/1/2003 -31.86 0.24 -0.33

40-20-40 Hedged Equity Portfolio 10/1/2003 -22.52 0.31 -0.28

40-20-40 Managed Futures Portfolio 4/1/2007 -19.71 N/A -0.18

40-20-40 Market Neutral Portfolio 10/1/2003 -9.39 0.67 0.32



18

Biggest Obstacles to Alternatives becoming Mainstream



19

Increased Importance of Alternative Investments



20

Convergence of Hedge Funds and Alternative Mutual Funds

× “Gartmore Group Ltd., a British manager of about 21.8 billion pounds($36 billion) that announced plans for an initial public offering lastweek, said it’s aiming for a ‘convergence’ of hedge-fund and mutual-

fund investments.” Bloomberg.com November 24th

× “Competition and Convergence: The Evolving Landscape for Hedge

Funds,” study commissioned by Pershing LLC May 2009× “The projection of growth in equity long/short investing by

[traditional] investment managers shows the sector reaching$345 billion in assets by 2012, up from $204 billion today.”

× Hedge fund companies venturing into mutual fund land:

× AQR, AlphaSimplex, Bull Path, Highbridge



21

Questions & Comments

× Nadia Papagiannis

× [email protected]

× 312-384-4100× Scott Burns, Director of Alternative Investments

× [email protected]

× 312-696-6586

mailto:[email protected]






22

Morning Star Mainstreaming Alternative Investments December 2009

Documents

Transcript of Morning Star Mainstreaming Alternative Investments December 2009