As equity prices move higher and bonds remain expensive (despite the recent sell-off), investors are increasingly seeking an alternative home for clients’ capital in the hope of delivering returns above cash deposits while maintaining capital values in the event of sharp moves in equity or bond prices.
It is therefore unsurprising that the alternatives Ucits funds have been one of the most popular destinations for European investors’ capital in 2016, with €21bn flowing into funds in these categories the first three-quarters of the year.
However, the alternatives universe can be a bewildering place due to the wide number of strategies available. It is possible to track 20 alternative categories across Europe populated by over 2,300 funds.
Despite this additional granularity, though, Morningstar does not currently publish average performance numbers for these categories as the underlying funds are not sufficiently homogenous to make a category average meaningful for investors.
It seems that this variety is creating confusion among investors, advisers and portfolio managers who have become reluctant to engage with such a diverse range of investment options. Evidence for this view is provided by the concentration of flows into multi-asset absolute return funds. This category has accounted for 48 per cent of net capital inflows since the beginning of 2014.
These funds do not fit well into a typical asset allocation template but instead form a sub-portfolio that is carved out of the main portfolio. Consequently, investor enthusiasm for such products appears to indicate desire to achieve a return stream rather than gain to particular asset or strategy exposure.
Other categories and the funds that populate them have seen much more muted support from investors. Seven categories have an average fund size of less than €100 million per fund and a further seven have average fund sizes of between €100 and €200 million. These figures are important as many portfolio managers look for a minimum of €100 in capital allocating to a new fund. Hence a category with lower than €100 million per fund is less likely to raise further assets quickly.
Further evidence of this confusion is provided by concentration of flows and assets in a small number of funds. While this is most noticeable in some of the smaller categories, it is equally evident at a higher level with 50 per cent of flows in the year to June 2016 being directed into just 10 funds. This concentration is similarly evident at the asset level with 22 per cent of the assets in alternatives funds being invested in the top 10 funds.
Alongside confusion, this extreme level of concentration may reflect a lack of quality in the alternative funds universe. At present only 20 funds carry a positive Morningstar analyst rating, representing 0.84 per cent of the total funds available.
This dearth of quality can also be surmised from the poor performance of alternative funds in aggregate. While past performance is not a guide to future returns, it is one of the best ways of assessing the achievement of managers and is especially relevant for alternative funds as they should be less susceptible to asset price movements.
Past performance should therefore be primarily determined by the luck and skill of the manager, which are indistinguishable over the short term. Viewed in this way, alternatives managers have been either unusually unlucky or lack demonstrable skill. Only 43 per cent of funds have achieved a positive return in 2016, a little worse than the 55 per cent that achieved it in 2015 and 72 per cent in 2014.
