Spouting Rock Monthly Commentary: Liquid Alternative Assets – August 2016

Nontraditional Bond Funds Can’t Shake their Outflow Trend

All asset figures stated and depicted are as of August 31, 2016

Aug1

For August, net asset flows for “Alternative” mutual funds (again, now including Long/Short Credit) were negative for the fifth month in a row, but YTD net flows remain positive (+$2.8B). Managed Futures continued to see net inflows in August, along with a smidgen for Long/Short Credit.  Managed Futures have now experienced 14 straight months of positive net flows. The Liquid Alternatives space as a whole (including Nontraditional Bond Funds) experienced net outflows again in August (-$1.7B) as the Nontraditional Bond category experienced its now 21st consecutive month of net outflows (-$1.3B for August). Most other strategies saw marginal net outflows.

Aug2

Monthly Focus: Managed Futures Funds Come In Many Different Forms
For almost a year now, month after month we have commented about the net inflows that the Managed Futures category, within Alternative Mutual Funds, has experienced. We have also discussed the massive inflows and ballooning of assets of the AQR family of Funds and the market share the AQR family and their broader category have taken in the last 12 months. We thought it would be prudent to briefly discuss a few different forms in which Managed Futures Funds are offered in the current marketplace.

The first form is the most simple, but two-pronged. We will refer to this form as Form A for this discussion. Form A is a single Fund sub-advised by a single portfolio management team. Form A may be owned and sub-advised by different companies or by the same parent investment firm as is the case with AQR Managed Futures Strategy. In both cases, specialized teams or asset managers are charged with portfolio management/trading while the Fund Management team oversees the Fund and its day-to-day operations.

The second is Form B, where the Fund Management company recruits several sub-advisors (asset managers) to manage assets of the Fund. Some Funds may have 2, 3 or even as many as 12+ different sub-advisers/ asset managers managing a slice of the assets under management. Now when we look at the Managed Futures space and or more specifically the Systematic Trend Following and CTA asset managers out there, most have built fairly unique “programs” and have differentiated views of what a “trend” is and what trigger “signals” to initiate trades across a unique blend of futures markets in their portfolios. Some asset managers may trade more commodity or FX markets than others, while some may view a trend in price of a particular futures market differently; derived from a lookback of days, months or even years. So in an attempt to build a diversified portfolio or Fund of different systematic strategies, a Fund Management company will contract several asset managers to garner a certain risk profile, diversification or exposure. Now whether this is a necessary effort to obtain a desired level of diversification, that is for allocators and investors to decide.

Whether a Fund is Form A (single sub-advisor) or Form B (multiple sub-advisors), the last major differentiator is how a Fund acquires fees on assets under management (“AUM”). All Funds charge a management fee in the form of a net expense ratio. Some, and certainly not all Managed Futures Funds also charge an incentive or performance fee based on returns above a high water mark. The way that these asset managers or sub-advisors do so is by charging this incentive fee on the assets they manage in which the Fund itself garners exposure through a Swap. Because this additional incentive fee is charged within the Swap, the fees themselves do not show up in the Mutual Fund’s normal fees/expenses. It is important to ask the Fund Management company and read prospectus carefully as to what the fee arrangements are for the Fund and their sub-advisors whether within the parent company or outside. Many Funds have taken steps to make this information more straightforward but too many continue to be less pronounced about such fee arrangements and the true fees an end investor may be subject to. Lastly, when allocating Alternative Mutual Funds, we think it is prudent to be less binary (high or low) when thinking about the cost of acquiring certain alternative strategies. If the exposure differentiated and performance is worth the fee, no matter the nominal cost, then that should be a significant factor in deciding between accessing high quality managers/strategies with daily liquidity or simply paying lower fees.

Managed Futures are one of the Alternative Mutual Fund categories that have made huge strides in attracting high-quality investment firms from the private, hedge fund universe into the retail space of Liquid Alternatives; improving the offering significantly in recent years. It should also be noted and questioned what version of the sub-advisor’s (investment firm) flagship (hedge fund) strategy is being translated into Liquid Alternative fund/exposures, as we believe that rarely is it the full version of the sub-advisors private fund due to the fact that their private investors/clients in the hedge fund are full-fee paying investors and exist as their core business.

Aug3

As always, we continue to monitor the universe for new fund launches (and closures) as well as observe the flow of assets and any other quirks the Liquid Alternative OE mutual fund world might throw at us. As the Liquid Alternatives universe continues to mature, it is likely that assets will continue to flow towards “Alternative” funds of the single manager variety.

Spouting Rock

Apr4

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