Commodity related mutual funds (including exchange-traded funds) have become very popular. These funds provide a easy way to gain exposure to specific commodities (e.g. gold) or broad baskets (e.g. the energy complex) with a small capital commitment, liquidity, and professional administration and management. The funds are touted as priding diversification through non-correlated performance and/or inflation protection.
Many of these fund gain exposure to the commodities through futures contracts. The market is active and deep, providing an efficient means to participate in the price movement of the selected commodity.
Now the Commodities Futures Exchange Commission (CFTC) is asserting its regulatory authority over these funds, according to a story in Investment News. The funds have relied on a rule exclusion that had allowed the funds to avoid registering with the CFTC. Effective January 1, those funds that invest primarily through the futures markets will be required to register as commodities pools and the fund managers to register as commodities pool operators.
Naturally, the funds are opposed, citing the regulatory oversight by the Securities and Exchange Commission (SEC). Other negative affects of the move by the CFTC would be the potential application of conflicting regulations, and increased costs. All of these costs would be to the ultimate detriment of the investor.
Nevertheless, the move is appropriate. Futures contracts and the exchanges on which they are traded are fundamentally different from stocks and bonds and their respective markets. In their composition and operation, these funds are clearly more like commodity pools than your typical mutual fund. So, the additional regulation is relevant, along with SEC oversight of the mutual fund vehicle.
Of course, this will bring up another regulatory question: Who is qualified to recommend the purchase of one of these funds? Will broker/dealers require advisors to acquire a FINRA Series 3 or 31 registration? If the B/D is going to be held responsible for CFTC compliance with regard to these products, I would expect it to adopt the requirement. Of course, since there is no such requirement for an unaffiliated Registered Investment Advisor, it would another nudge down the path of diminishing independent B/D competitiveness.
Showing posts with label Mutual Fund. Show all posts
Showing posts with label Mutual Fund. Show all posts
Tuesday, April 17, 2012
Friday, April 22, 2011
Absolute Return Funds
Saw an article on Bloomberg.com, about absolute return funds. The premise of the story is that "Absolute Return" does not describe a strategy so much as a desired outcome. This makes comparing funds difficult. What the heck, let's give it a go anyway.
First, a li8ttle ground work. Absolute return strategies are common in the hedge fund arena, describing funds that attempt to provide a positive return each month. Most of the strategies are either arbitrage or market neutral in their approach. (There are some funds investing in illiquid assets calling themselves absolute return, but the illiquidity masks the volatility of the asset values.) These strategies rely on techniques that greatly reduce the risks associated with specific market exposure. Portfolios tend to have roughly equal long and short exposures.
I ran a screen on Morningstar's Principia product, seeking funds in the Morningstar categories "Market Neutral" and "Long-Short". We searched for distinct portfolios only that had started operations before January 1, 2008, and had a= 3-year annualized return through March 31, 2011 greater than 0%. The screen returned 24 funds.
Since we are looking for returns that are not correlated with any markets, I checked the Best Fit R-Squared and found five funds with a score below 30. One was closed and one showed no assets (?). One has very relatively volatile returns. The two remaining look interesting.
JP Morgan Research Market Neutral (JMNAX, Cl A) is managed by JP Morgan in a market- and sector- neutral strategy. Through March 21, 2011, it has a 3-year annualized return of 2.20% including -1.06% in 2008. Its best Fit R-Square is 8. It has an expense ratio of 1.50% (capped until 2/29/2012).
Managers AMG FQ Global Alternatives (MGAAX, Cl A) is managed by First Quadrant L.P. in a quantitative strategy that seeks to remain neutral across markets, sectors, and currencies. The fund returned 1.16% annualized for the 3 years ending March 31, 2011, including 4.84% in 2008. It has a Bet Fit R-Squared of 22w and an expense ratio of 1.99% (capped until 3/31/2012).
These two funds are available in multiple shares classes, so an advisor should be able to find the fund that meets the all client goals. Either fund should provide some dampening of capital volatility while producing a return well in excess of cash equivalents.
First, a li8ttle ground work. Absolute return strategies are common in the hedge fund arena, describing funds that attempt to provide a positive return each month. Most of the strategies are either arbitrage or market neutral in their approach. (There are some funds investing in illiquid assets calling themselves absolute return, but the illiquidity masks the volatility of the asset values.) These strategies rely on techniques that greatly reduce the risks associated with specific market exposure. Portfolios tend to have roughly equal long and short exposures.
I ran a screen on Morningstar's Principia product, seeking funds in the Morningstar categories "Market Neutral" and "Long-Short". We searched for distinct portfolios only that had started operations before January 1, 2008, and had a= 3-year annualized return through March 31, 2011 greater than 0%. The screen returned 24 funds.
Since we are looking for returns that are not correlated with any markets, I checked the Best Fit R-Squared and found five funds with a score below 30. One was closed and one showed no assets (?). One has very relatively volatile returns. The two remaining look interesting.
JP Morgan Research Market Neutral (JMNAX, Cl A) is managed by JP Morgan in a market- and sector- neutral strategy. Through March 21, 2011, it has a 3-year annualized return of 2.20% including -1.06% in 2008. Its best Fit R-Square is 8. It has an expense ratio of 1.50% (capped until 2/29/2012).
Managers AMG FQ Global Alternatives (MGAAX, Cl A) is managed by First Quadrant L.P. in a quantitative strategy that seeks to remain neutral across markets, sectors, and currencies. The fund returned 1.16% annualized for the 3 years ending March 31, 2011, including 4.84% in 2008. It has a Bet Fit R-Squared of 22w and an expense ratio of 1.99% (capped until 3/31/2012).
These two funds are available in multiple shares classes, so an advisor should be able to find the fund that meets the all client goals. Either fund should provide some dampening of capital volatility while producing a return well in excess of cash equivalents.
Monday, February 7, 2011
The New Indexing
Index investing has been around for a long time. The Vanguard 500 fund was formed in 1976, and institutional indexing is older still. The attractions are abundant: inexpensive implementation, broad diversification, complete exposure to a market, straightforward monitoring.
Traditionally, indexes have been constructed on a cap-weighted basis. This was done so that the performance of the index would reflect the return available to an investment in the entire market, the investable universe. Thus, a security that represents more invested capital, or a higher market capitalization, is included in the index with a greater weight than a security with a lower market cap.
This size-weighting is counter-intuitive, given the studies suggesting that superior returns can be earned by investing in small companies, companies with low P/E ratios, and companies that pay dividends. For a long time, these anomalies were exploitable only through active management, along with the higher implementation costs. Consulting firm Russell Investments was one of the first to formalize a set of indexes to measure size and style cohorts that were fully inclusive and accounted for the entire capitalization of the market. Investable products followed. But the indexes were still cap weighted.
The Wall Street Journal has an article (subscription required) about the new index products that use these factors to create alternative weighting schemes. The article highlights the funds, both traditional open-end and ETF, that are employing alternative weighting schemes, from equal weighted, to single-factor weighting to Research Associates' Fundamental Indexing. All of these new weighting schemes tend to outperform cap weighted indexes, though typically with greater volatility.
Clarity Finance has adopted a paired indexing strategy using both cap weighted and Fundamental Indexing schemes. Cap weighting ensures close tracking to the return offered by the investable universe and typically lower cost implementation than alternative schemes. Fundamental Indexing's use of multiple characteristics on which to weight holdings gives a better exposure to economic and (theoretically) return factors. The experience of the model portfolios has been performance net of fees comparable to the benchmark with similar volatility.
Traditionally, indexes have been constructed on a cap-weighted basis. This was done so that the performance of the index would reflect the return available to an investment in the entire market, the investable universe. Thus, a security that represents more invested capital, or a higher market capitalization, is included in the index with a greater weight than a security with a lower market cap.
This size-weighting is counter-intuitive, given the studies suggesting that superior returns can be earned by investing in small companies, companies with low P/E ratios, and companies that pay dividends. For a long time, these anomalies were exploitable only through active management, along with the higher implementation costs. Consulting firm Russell Investments was one of the first to formalize a set of indexes to measure size and style cohorts that were fully inclusive and accounted for the entire capitalization of the market. Investable products followed. But the indexes were still cap weighted.
The Wall Street Journal has an article (subscription required) about the new index products that use these factors to create alternative weighting schemes. The article highlights the funds, both traditional open-end and ETF, that are employing alternative weighting schemes, from equal weighted, to single-factor weighting to Research Associates' Fundamental Indexing. All of these new weighting schemes tend to outperform cap weighted indexes, though typically with greater volatility.
Clarity Finance has adopted a paired indexing strategy using both cap weighted and Fundamental Indexing schemes. Cap weighting ensures close tracking to the return offered by the investable universe and typically lower cost implementation than alternative schemes. Fundamental Indexing's use of multiple characteristics on which to weight holdings gives a better exposure to economic and (theoretically) return factors. The experience of the model portfolios has been performance net of fees comparable to the benchmark with similar volatility.
Thursday, February 3, 2011
Hedge Fund Strategy in a Mutual Fund
HedgeCo.Net carried an announcement of the opening of the Frost Diversified Strategies Fund (FDSFX), which is supposed to provide "investors access to alternative investment management strategies previously available to hedge fund and private equity fund investors." The objective is to appreciate in up markets and outperform in down markets. The fund will have 60% of its assets invested in traditional assets and 30% of asset will be invested in a "hedge replication module" which will be supported by "publicly available products." Apparently, the hedge replication module will be invested primarily in products that replicate the performance of hedge fund, commodity, and currency indexes. The fund carries a 0.80% management fee and expense ration of 2.00%.
Mutual funds trying to utilize or replicate hedge fund strategies are not new. PIMCO Total Return has used futures, options, and swaps strategies to add value in a very competitive bond market. A few years ago saw a wave of "130-30" funds attempting to implement the original hedge concept. And about three years ago, Absolute Investment Advisors launched the Absolute Strategies Fund (ASFIX), a fund that employs eleven sub-advisors, each of which manages a portion of the fund using a strategy typically reserved for hedge funds. There are also those publicly available products to provide exposure to alternative strategies.
The point is that there are many options available to the individual investor to participate in alternative assets and strategies, most with a lower cost structure and almost all with a track record that can be evaluated. FDSFX may emerge as a viable option, but I would recommend patience in assessing its usefulness.
Mutual funds trying to utilize or replicate hedge fund strategies are not new. PIMCO Total Return has used futures, options, and swaps strategies to add value in a very competitive bond market. A few years ago saw a wave of "130-30" funds attempting to implement the original hedge concept. And about three years ago, Absolute Investment Advisors launched the Absolute Strategies Fund (ASFIX), a fund that employs eleven sub-advisors, each of which manages a portion of the fund using a strategy typically reserved for hedge funds. There are also those publicly available products to provide exposure to alternative strategies.
The point is that there are many options available to the individual investor to participate in alternative assets and strategies, most with a lower cost structure and almost all with a track record that can be evaluated. FDSFX may emerge as a viable option, but I would recommend patience in assessing its usefulness.
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