Time to Consider Alternatives to Money-Market Funds

Recently, our firm decided to expand our universe of "safe haven" funds. As a tactical asset manager, we rely heavily on such funds, especially during weak market conditions, when we rotate investors' portfolios out of the stock market.

We looked at several alternatives and these four—two ETFs and two mutual funds—made our short list. The ETFs were more traditional, giving us more of a pure play fixed income assets; while the mutual funds were true alternative investments, offering non-correlated exposure to specialized asset classes within a relatively conservative, actively managed investment strategy.

iShares Barclays Short Treasury Bond ETF (SHV). SHV is a plain-vanilla fund that tracks the Barclays U.S. Short Treasury Bond Index, which measures the performance of Treasury securities that have a remaining maturity of one to 12 months. This is an attractive money market alternative because it avoids the underlying exposures that most traditional mutual funds have, including repos and other collateralized and uncollateralized transactions. And, of course, the ETF structure is a good way to maintain liquidity.

PIMCO Enhanced Short Maturity Strategy ETF (MINT). MINT, as described by PIMCO, "is an actively ETF that seeks greater income and total return potential than money market funds, and may be appropriate for non-immediate cash allocations. MINT will primarily invest in short duration investment grade debt securities. The average portfolio duration of MINT will vary based on PIMCO's economic forecasts and active investment process decisions, and will not normally exceed one year. MINT will disclose all portfolio holdings on a daily basis, and will not use options, futures or swaps."

The fund's portfolio manager, the above-mentioned Jerome Schneider, is keenly aware of the risks that Bernanke and others have expressed. This fact offers some measure of confidence that he may be able to manage through bumps in the landscape.

We like that the fund seeks to outperform typical money market funds by owning longer maturity bonds and a broader universe of investment-grade fixed income securities. As the well-known leader in fixed income, PIMCO has always had talented portfolio managers and analysts. The ETF structure, which provides daily liquidity and full transparency, is also a positive.

Bishop Volatility Flex Fund (BVFVX). This fund takes a step out on the risk spectrum—a rather small step. The prospectus says that it holds 90% of its assets in U.S. Treasury securities; the other 10% of assets are used to purchase options on the S&P 500 Index.

The fund seeks to monetize volatility using a non-directional methodology that invests in option spreads. The objective is to preserve principle while generating upside return regardless of market direction. The Volatility Fund uses an unleveraged approach, simultaneously holding both long and short positions providing the potential to capture returns in both rising and falling market volatility environments.

This fund can be used as an alternative to money market funds or to add another level of diversification. Bishop says the fund was designed to act as a "shock absorber" for investors' portfolios.

The fund is relatively low-risk and because it trades off volatility—market movement both upward and downward—the fund's performance is neither positively correlated nor inversely correlated to other asset classes. In fact, the correlation numbers on this fund are excellent. It is uncorrelated to all of the asset classes we measured, including domestic and international stocks and bonds, real estate, currencies, commodities and managed futures.

Sarasota Capital Strategies Currency Strategies Fund (FOREX). Like the Volatility Fund, this fund is also more risky than traditional money market funds. It too is uncorrelated to most other asset classes, making it a good tool for portfolio diversification and reduced volatility, and has the potential to enhanced returns.

The currency markets are very dynamic, in part because currencies are valued relative to each other. If currencies are a zero-sum game, they must be traded in order to generate profits. The portfolio managers at Sarasota say, "The trading models with the most explanatory power are those that emphasize order flow in a multiple dealer, simultaneous trade market." In other words, the supply and demand for currencies best explains exchange rate fluctuations. The best way to measure supply and demand is through technical analysis.

The portfolio managers run multiple, equally-weighted indicators that are diversified across time frame and strategy to achieve three main goals:

1. Achieve low correlation to other asset classes
2. Limit volatility (They target a standard deviation of less than 1% based on monthly returns.)  
3. Provide investors with an additional asset class for diversification and hedging purposes 

It is impossible to accurately measure the risks of exposure to the U.S. shadow banking system, which may alone be a good enough reason to avoid it. But that doesn't mean risk assessment can't be done.

As the investment management industry continues to innovate, offering investors a vast array of alternative investment solutions, advisors should take the time to learn about how these alternatives can benefit their clients and their practice.

Interest in alternative investments has exploded in recent years because investors are demanding a greater emphasis on risk management. Investment managers and innovative fund companies are responding by creating products to meet the demand for greater diversification, reduced volatility and the potential of returns regardless of the performance of traditional asset classes.

Schreiner Capital Management has a portion of client assets invested in BVFVX.