Making Sense of Fancy-Math Investing
WHY YOU SHOULD CARE
These fancy-math investment vehicles are multiplying like rabbits.
How do you make a living if you can’t cut it as the lead guitarist of a has-been rock band? Well, if you’re Larry Restieri, sell hedge fund investments to the masses, of course. But maybe there’s logic there, since connecting to an audience is an important skill for Goldman Sachs’s chief barker of one of the hottest and fastest-growing investment products out there today: so-called liquid alternative mutual funds. He’s got his job cut out for him.
Many investors these days have an unusual dilemma. Namely, they’ve been making a ton of money over the past six years and, until very recently, they’ve really only seen markets go up. Hardly any fancy investment strategies have been able to beat old-fashioned, tried-and-true approaches, like buying and holding stocks and bonds. But Restieri, who spearheads sales of alternate investments at Goldman, the investment bank, is joining others in warning investors not to be lulled into a false sense of security. “Most people are saying this is great,” says Dick Pfister, chief executive at financial advisory firm AlphaCore — but that makes it hard to change direction. With stock and bond prices so high, Pfister warns, most investors are assuming far more risk than they realize, which is why he and others suggest investors consider a little portfolio insurance just in case the market tanks, like it did twice in the past 15 years.
In a sense, liquid alts make investment technology that’s been the exclusive preserve of the wealthy available to ordinary people.
What, exactly, are they recommending? Liquid alts are essentially hedge fund products pitched at the masses and packaged as mutual funds, which can be bought and sold daily by investors with a few thousand dollars, compared with hundreds of thousands for a hedge fund, and come with much heavier regulation by the Securities and Exchange Commission, presumably making them safer. Although hedge funds have gained fame among certain risk takers — for example, George Soros taking on the Bank of England on a bet against the British pound — many hedge fund strategies are aimed at making money while reducing risk. Managers can bet against the market, or do stuff like bet that Coke will outperform Pepsi, even if both go up or down. “We think of them as hedge fund-like strategies in a daily liquid mutual fund vehicle,” Restieri explains. Funds can bet on changes in foreign currency exchange rates, or make wagers during corporate takeover attempts in so-called event-driven funds.
In a sense, liquid alts make investment technology that’s been the exclusive preserve of the wealthy available to ordinary people. And these fancy-math investment vehicles, like BlackRock Strategic Income Opportunities or Goldman Sachs Strategic Income, are multiplying like rabbits. Morningstar, the fund-research company, recently counted 638 of the funds, including what it calls nontraditional bond funds, an increase of 43 percent since the end of 2012. Even Vanguard, the champion of low-cost index fund investing, is getting into the act with the pending launch of its Alternative Strategies Fund for investors with at least $250,000. John Ameriks, who heads Vanguard’s Quantitative Equity Group, points out that Vanguard already has other products in the area, including the Managed Payout Fund, which aims not to match or beat the market but to keep pace with inflation while allowing a 4 percent annual payout from the fund.
So if investor-friendly Vanguard is hopping aboard this latest trend, it must be a safe bet, right? Not necessarily. “People need to go in eyes open,” says Ameriks, warning that there’s no such thing as a return that doesn’t carry its own risk. Adam Nash, chief executive of money manager Wealthfront, says that some hedge funds have been fantastic, but adds, “average results for those products have been terrible.” His company’s research showed that a Wealthfront-type portfolio of low-cost index funds was hit harder in 2008 than the average hedge fund, but bounced back more quickly in the aftermath. Liquid alts also tend to carry high expense ratios, sometimes over 2 percent annually, much cheaper than a hedge fund, but 40 times that of the cheapest index funds.
For their part, proponents defend their strategies but agree investors are taking on risks. “I get the concerns,” says Restieri. Still, he contends that hedge funds have performed well over a much longer period, going back to 1990. “I’ve seen what they do to my own account,” he says. That’s why, he argues, these kinds of products could be a good buy for ordinary folks saving for college tuition or retirement — because their principal aim isn’t to beat the market in any one year, it’s to reduce losses when the market tanks.
Goldman has tried to simplify the selection by assigning the funds to five different categories, compared with 15 at Morningstar, and bases the groupings on hedge fund experience, including the catchall “multistrategy.” But so far, for ordinary investors, or even professional advisers, sorting through the products and finding a star performer has been confusing at best. “Investors need an expert to help them wade into the waters,” says Pfister.