Multialternative funds have been the fastest-growing alternative category, according to Morningstar data, adding $17.6 billion in net new assets last year, an organic growth rate of 44 percent. Thirty new funds were launched in the category last year. But when it comes to investing in these funds, Morningstar warns: Buyer beware. These funds have been successful raising capital based on their promise of absolute returns, lower volatility and reduced correlations to traditional assets. Yet the average multialternative fund has fallen short.
“Investors have sought multialternative funds to gain easy access to a diversified set of alternative strategies in one fell swoop. Moreover, many investors have been attracted by the opportunity to get access to true hedge funds through multialternative funds,” Morningstar analysts write in the latest Alternative Investments Observer. But, “there has been a wide gap between the stated objective of the typical multialternative fund and real-world returns.”
Multialternative funds, most of which have short track records, have been dogged by high fees and lackluster performance. Morningstar believes most funds won’t outperform peers or a relevant benchmark over a full market cycle; that’s why the research firm recommends few of these funds.
The multialternative category returned an average annualized 0.69 percent over the three years ending January 2016, Morningstar says. That compares to market-neutral funds, with an average three-year return of 1.21 percent; managed futures funds, up 2.89 percent over that time; and long-short equity funds, which gained 3.15 percent during that period.
The three-year correlation of the category was also pretty high, at 0.88, indicating that the funds aren’t delivering on their diversification promise, while a three-year Sharpe ratio of 0.07 points to a limited risk/reward trade-off.
Morningstar points to several reasons for the underperformance.
“At the macro level, for several years after the global financial crisis, the coordinated quantitative easing efforts of central banks led to lower volatility and higher correlations in asset classes, a hindrance for many multialternative strategies that thrive on dispersion between asset classes and dislocations in the markets,” the report says.
The performance of these funds has also been hindered by their weightings to global equity and event-driven strategies, which have gone south as big deals broke in 2014 and 2015.
Poor manager selection, Morningstar adds, also led to underperformance in some funds.
Another sticking point for these funds is their fees, which are higher than traditional and other alternative categories that Morningstar tracks. Multistrategy funds of hedge funds have the highest fees, charging the typical 1 percent management fee paid to underlying subadvisors in addition to other fund operating and administrative fees.
“Fund companies argue that highly specialized hedge fund managers do not come cheaply, but we believe that few funds can overcome such high fee hurdles, and thus far, most managers have not generated performance sufficient to justify the cost,” the Morningstar report said.