Exchange traded funds that replicate hedge fund strategies or track liquid alternatives are a good way to diversify a traditional equity and fixed-income portfolio to lower the potential negative effects of a volatile market ahead.
“Current equity market levels and the prospect of rising rates may mean lower returns and higher volatility in traditional portfolios,” Yazann Romahi, Portfolio Manager and Head of Global Multi-Asset Research in the Multi-Asset Solutions Team at J.P. Morgan Asset Management, said on the recent webcast, Look to Alternatives as Traditional Stocks, Bonds Run on Fumes.
After an equities generated an almost 200% return from the lows of 2009, investors should not expect the good times to last forever and brace for single digit returns with potentially greater volatility ahead. Meanwhile, the fixed-income market has enjoyed a multi-decade bull run as yields pushed toward record lows, but its is now more likely that interest rates will go up and pressure debt securities.
In a survey of financial advisors attending the webcast, the majority of respondents, 42.0%, pointed to global uncertainty as the biggest point of concern over the next 12 months, followed by 39.0% pointing to bear market in equities and 19.0% worrying about rising interest rates.
[related_stories]Alternatively, investors can look to liquid alternatives that can produce diverse investments strategies, attractive risk-adjusted return potential, downside mitigation and potentially reduce market sensitivity.
Mark Matthews, Investment Research Analyst at CLS Investments, points to a number assets that may fall under the liquid alternatives category, including commodities, currencies, convertible bonds, preferred stocks and VIX options, along with other hedge fund-like strategies.
Jillian DelSignore, Executive Director and Head of ETF Distribution at J.P. Morgan Asset Management, explained that once an investor has a sense of his or her investment outlook, one would need to decide what type of alternative strategy to adopt.
For instance, a hedge fund index replication technique would use historical statistical relationships to replicate historical performance of a broad hedge fund universe. Alternative beta uses expanding systematic, rules-based investing of various hedge fund styles. A global macro approach is a macro-driven investment style that invests tactically across stock, bonds, currencies and commodities across the global. A multi-manager provides access to highly skilled hedge fund managers.
“Have clear expectations for what you want out of your alts allocation overall relative to your current starting point,” DelSignore said. “Where do you have the biggest risk in your portfolio today? Is it equity risk, interest rate or credit risk, or maybe both?”
In the survey of financial advisors, 49.0% revealed their preference for allocating a greater portion of their portfolios to alternative investments by the end of 2016. However, 21.0% of advisors said they required more information, which suggests that the industry still needs to reach out to further educate investors about the benefits of liquid alts.
Large institutional-sized investors have traditionally turned to hedge funds as a way to gain exposure to these alternative strategies. However, hedge funds come with high management fees of 1% to 2% on top of a performance fee of as much as 20% of annual gains. Luckily for ETF investors, there are now a number of ETFs that specifically deliver hedge fund-esque strategies.
“Hedge fund strategies can provide several key benefits to clients, but fees can meaningfully reduce return capture,” Romahi said. “Alternative ETFs seek to provide low cost access to hedge fund strategies and capture their unique attributes.”
SEE MORE: J.P. Morgan Rolls Out Its First Active ETF Strategy
For example, investors can look to the recently launched JPMorgan Diversified Alternatives ETF (NYSEArca: JPHF), J.P. Morgan’s first actively managed ETF to hit the market. The fund combines various hedge fund-esque, alternative investment strategies in an easy-to-use ETF wrapper. Specifically, JPHF will include equity long/short, event driven and global macro based strategies. The ETF comes with a 0.85% expense ratio.
Financial advisors who are interested in learning more about alternative investment strategies can watch the webcast here on demand.