It has been an amazing 12 months for stocks, as the equity bull market stretched into its ninth year and stock prices increased every month of the year for the first time in history.
But there were losers too: namely alternatives, which were shunned by investors who shifted their focus to chasing returns instead of diversifying and reducing risk.
While many investors continue to expect a strong market in 2018, boosted by solid corporate earnings and an expanding US economy amid tame inflation and synchronized global growth, others have started to worry about the effects of a market normalization or even a sharp correction.
We caught up with three liquid alts experts to get their views on the market for the past year and the next 12 months.
Wells Fargo Investment Institute
Senior research director, global manager research
While liquid alts were left in the shade by equities, all sub-categories within liquid alts produced positive returns in all four quarters of 2017 – except for global macro, which returned -1.03% in the second quarter due to fluctuations in the global fixed income markets, Gill said.
He added that all five major liquid alternative categories – equity hedge, event-driven, global macro, relative value and multi-strategy – finished 2017 with positive performance.
‘As measured by the Wilshire Liquid Alternative Asset Class indices, which serve as our key benchmarks for the liquid alternative space, equity hedge led all liquid alt asset classes, up 7.6% for 2017,’ Gill said. ‘Equity hedge was closely followed by multi-strategy funds, which returned an aggregate 7.1%. Relative value funds combined to return 3.4%, while event-driven strategies returned 2.8%.
‘Global macro funds finished the year with a return of 4.3%, fueled by a very strong fourth quarter return of 3.2%, driven by strong trends in global equity and commodity markets,’ he added.
Senior manager research analyst
On the surface, the numbers for alts pale in comparison with the S&P 500, which has returned almost 20% over the past 12 months.
But Icten argued that it was simply not fair to compare liquid alts with equities. What's more, it might not be a bad thing for liquids alts to look different from the S&P 500 in 2018.
‘It’s not fair to compare liquid alternatives to an index like the S&P 500 because they trade multiple asset classes. Alternatives are not an equity asset class; in fact alternatives are not an asset class at all,’ Icten said. ‘It’s a combination of multiple asset classes, so when you look at it from that perspective, the fact that they did not outperform the S&P 500 is not necessarily a bad thing for alternatives.’
Icten said that within Morningstar’s classification system, the best performing liquid alts category was long/short equity, which generated 11.2% in 2017, followed by the options-based strategies category, which was up 9% for the year.
In the long/short equity category, Icten pointed to the AQR Long Short Equity fund, which was up 13.7%, and the Boston Partners Long/Short Research fund, which was up 10.1%, as examples of particular outperformers. In the options-based category, he highlighted the JP Morgan Hedged Equity fund, which was up 12.7%.
‘The worst performing categories are the market-neutral category, which was up about 2%, and the managed future category, which was up about 3%,’ he said.
‘In this market environment where the market reality is on a straight line, and with very low volatility, it’s generally not the best environment for market-neutral strategies because [they] generally run 100% long or 100% short portfolios and their short portfolios have been hurting them,’ he added.
Alternatives investment strategist
As underwhelming as the likes of market neutral were in 2017, Davis believes that they are worth looking into again in 2018, when a rising rate environment will likely create trading windows for such opportunistic strategies.
‘One of the reasons why I like global macro and managed futures going forward is my expectation that you are going to see higher levels of volatility coming back into the market. You are going to see the correlation levels both within asset classes and across asset classes normalize,’ Davis said.
‘As you get higher levels of volatility, it creates more opportunities for those strategies because they are typically unconstrained; they are investing long and short. Greater volatilities tend to present greater trading opportunities for them,’ he added.