Josh Brown recently wrote a piece, “How to Raise 20 Billion Dollarz,” that takes on alternative investments.1 Brown documented the rise and fall of an alternative strategy fund that crushed it during the 2008–2009 down market but has been a real dog during the straight-up market we've experienced ever since. This alternative strategy fund saw round-trip flows of $20 billion in assets chasing its performance and then moving out as it failed to keep up with the market's rip higher.
I write this post with some trepidation, as I will be leaning into liquid alternatives that Brown regularly mocks. My fellow bloggers are likely shaking their heads at the moment: “He's not the wisest of fellows.” But here goes anyway.
Describing the alternative funds that rose in popularity, Brown wrote:
Black Swan funds, tactical funds, liquid alts – they were expensive, they were complicated, they were high-falutin' in their literature – but they were seen to have worked. If you had an alts fund that was merely flat in oh-eight, you had the answer for every client question. And if you had one that actually made money in the crisis, it was as though you had stolen the Promethean fire from the gods.2
Morningstar weighed in on the challenge for alternative funds in a piece titled “Many Alternative Funds Have Disappointed Investors”.3 Morningstar cites the following problems:
High Fees. Hedge funds have historically charged 2% of assets and 20% of profits. Although that's starting to come down, some firms crossing into the mutual fund world to launch alternative funds have kept something similar to the 2%, though you can't also charge a percentage of profits in a mutual fund. If you're running a strategy that generates 5% annualized, that 2% is a huge cost for shareholders to bear.
Complexity. Many alternative strategies are incredibly complex. Naturally, it's harder for advisors and investors alike to set realistic expectations for such funds.
I wholeheartedly agree with both Brown and Morningstar. Perhaps the biggest issue with many of these liquid alternative funds is the high fees and lack of transparency in terms of a process for understanding inherent market exposures in these funds and how said exposures will change over time.
