The Making of a Headline…

The making of a headline
What goes into the making of a headline – a gripping quote or daring claim? Headlines have a lot of control over where end users spend their time; because of this they have the potential to be quite irritating when you feel you’ve been misled. In the case of a recent Bloomberg article (and to be fair other publications were just as guilty, but we pay Bloomberg enough to pick on them a bit) I must admit I felt a little vexed. At the end of the day, the headline “Oaktree’s Marks Warns Liquid-Alternative Funds Won’t Deliver” was only a somewhat accurate characterization of four sentences from an 11 page memo. The headline generating quote was:

So-called “liquid alternatives” or “liquid alts” are another recent innovation. They’re supposed to deliver performance comparable to other alternative investments without the illiquidity they entail. To me it sounds like just one more promise of something for nothing. How many portfolio managers are smart enough, for example, to deliver the alpha of a well-managed hedge fund without accepting the illiquidity that the clever manager of that hedge fund feels he has no choice but to bear?

Mr. Marks is right, many liquid alternative funds are bound to disappoint (as are many illiquid alternatives, by the way). This is especially true for strategies dabbling in illiquid markets such as distressed debt, the market where he has made his name. This is not news. Maybe Mr. Marks feels all liquid alternatives will fail to deliver. If that is his position, I can respectfully disagree. But either way, the problem I had with the article is it seems like they missed the whole point in order to generate a headline.

Oaktree’s memo did a great job of explaining the perils of evaluating strategies and vehicles in light of liquidity. Almost none of this had to do specifically with liquid alternatives, but instead was focused on any area where a liquidity mismatch exists or will exist at some point. True, this impacts liquid alternatives, but it also impacts small cap mutual funds, high yield bond funds and many more “traditional” investment arenas. The key point, as I interpreted it, was to be aware of what you are buying and what the underlying liquidity profile is (or could be) relative to the liquidity profile of the security being purchased. This is an extremely important lesson that was sacrificed for a headline.

Liquid Alts Corner

The Data

Once again managed futures produced the strongest returns during the month of March, gaining 1.76%. The remaining strategies were relatively flat. This leaves managed futures leading year to date and over the last 12 months by a very healthy margin, as they have produced a nearly 19% return during the last year compared to the nearest competitor, multialternative, which was up about 3.8%. However, even with such strong recent performance, the managed futures category as a whole has only returned a little more than 3% per year during the last 3 years. The Long/Short Equity category continues to be the long term best performing category, coming in at over 6% annualized over the last 3 years.

As flows tend to follow performance, it is no surprise that managed futures funds continue to garner assets at a relatively quick rate, gaining more than $850 million in net flows in March, bringing year to date flows to $2.3 billion. Also seeing strong flows was the multialternative category, which gained nearly $1 billion for the month and has now brought in more than $2 billion for the year. The long/short equity category had the most difficult month, shedding nearly $200 million in assets.

Another Merit Badge for Liquid Alternatives?
Even with the much maligned liquidity constraints (see introduction above) liquid alternatives outperformed their more illiquid counterparts in 2014. This is an admittedly short timeframe, but in a recent ThinkAdvisor article Jon Sundt, President and CEO of Altegris, argues that this may continue into the future. His reason:

The fact is that the competitive landscape has changed. Since 2008, a subtle shift has taken place among traditional hedge fund managers. Many now use less leverage, as little as 2:1, and many are investing in more liquid securities. In other words, many traditional hedge funds are beginning to look more like liquid alt funds. If imitation is the sincerest form of flattery, then hedge funds are acknowledging that liquid alts may be onto something. One big difference remains—the traditional hedge fund typically charges 2-and-20% in management and performance fees.

It only seems to reason that if the above is true, then traditional managers are becoming more liquid and utilizing less leverage, then, as a group, they can’t help but underperform given their typically much higher fee structures.

Hedge Funds in the News

Are Hedge Funds Evil?
Are hedge funds evil? Or could they actually be a benefit to society? AllAboutAlpha has a good write-up addressing some of the issues surrounding the negative perception of hedge funds among the general public.

Two Sigma Sues Former Quant for Starting His Own Hedge Fund
Hedge fund Two Sigma is suing a former quantitative analyst claiming that he breached his non-disclosure and non-compete agreement by forming a new hedge fund which he has been marketing to prospective investors. This isn’t Two Sigma’s first bout with lawsuits regarding former employees. Last year they sued Kang Gao, another quantitative analyst, for stealing trading models from the firm. He was ultimately found guilty of unlawful duplication of computer-related material and is awaiting sentencing. In 2007 they settled another lawsuit against an analyst for stealing intellectual property. On a brighter note, Two Sigma had an interesting article written up about them in The Wall Street Journal this month, highlighting the methods they use to find exploitable market opportunities. The article is definitely worth a read.

The Oracle of Omaha once said that “Diversification is protection against ignorance; it makes little sense for those who know what they’re doing.” With respect to Mr. Buffett, we’d disagree, at least with the second part of that statement; even investors who know what they are doing need protection against ignorance – ignorance of, or uncertainty about, the future that is. Of course it’s one thing to diversify the idiosyncratic risk in a stock or bond portfolio – that isn’t particularly difficult – and to Mr. Buffett’s point, if you have intimate knowledge of the companies in a portfolio, as he does, then broad diversification probably doesn’t make sense. But if your goal is to build a portfolio that you can actually stick with over multiple market cycles, including tumultuous times, and that similarly you can count on to compound returns with some consistency, then proper diversification is a must. While true diversifiers are rare, there is a clear winner – Managed Futures.
(Read more in Utilizing Managed Futures Strategies)

And Lastly…
Just in case you were wondering


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