The number of liquid alternative-investment mutual funds and exchange traded products continues to grow. According to Morningstar analyst Michael Coop, mutual -fund companies have launched an average of four new products each month in these categories over the past five years: Investors are noticing: Alternative mutual funds held $122 billion at year-end 2011, the culmination of five consecutive years of inflows, Morningstar estimates.
Although U.S.-equity mutual funds still held more assets with $260 billion, these more-traditional funds had experienced five consecutive years of outflows.
After a strong run-up in the first four months of 2012, U.S. equity markets started to drop in May, which conceivably could lead to greater interest in liquid alternatives. Before jumping in, advisors and investors looking for liquid alternatives that offer bear-market performance may want to look at how the various liquid alternative categories performed during some recent pullbacks.
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To track such performance, Morningstar uses seven different classifications for liquid alternatives: bear market; currency; long/short equity; managed futures; market neutral; multi-alternative and nontraditional bond, explains Mallory Horejs (left), an alternative-investments analyst with the Chicago-based research and ratings firm.
Each category has a unique risk/reward profile, Horejs notes, and bear-market funds provide the purest downside play. "I think almost all the funds in this category are just pure inverse index products," she said in an interview with AdvisorOne. "So, they're certainly the top performer during different periods of financial distress.
Last year, when the market fell about 17% from April to October, these funds were up 20%, "because they're just providing the inverse of the index," Horejs notes. Among the other categories, currency and market-neutral have been the best for downside protection, the analyst adds, which reflects the underlying portfolios.
