Do Liquid Alternatives Help A Portfolio’s Risk Adjusted Return?

Posted on August 14, 2018 by Gemmer Asset

image_printPrintable Version

I won’t beat around the bush, the answer to this question is, like many things, nuanced. It really depends on the alternative fund/vehicle you use. Obviously with hindsight we can pick the best fund, but its another story when you’re trying to make a judgement about whether or not an alternative fund will be additive to your portfolio ex-ante.


Morningstar came out with an interesting paper on this topic. In it, Jason Kephart attempts to asses whether alternative funds in existence since 2012 have improved a 60/40 model portfolio’s risk-adjusted return. The results of the analysis can be summed up in the below chart.



A huge majority of funds failed to improve the model portfolio’s Sharpe Ratio over the past five year period (and these numbers undoubtedly benefit from survivorship bias). Why is this the case? Well it may have something to do with rising correlations between alternative strategies and traditional stock/bond allocations.



Lower correlation between assets provides a diversification benefit – reducing volatility. Lower volatility while holding returns constant leads to higher risk-adjusted returns (Sharpe Ratio). Higher correlations reduce these positive diversification effects.


This article is basically saying that its been very hard to justify having a meaningful chunk of alternatives in a diversified portfolio over the last 5 years.


Now if you also consider the high fees of most alternative strategies, the case for alternatives becomes even tougher to make.



The fees for these strategies have also been on the rise while funds fees among traditional asset classes have been falling…



Bottom line, adding a slice of liquid alternatives now is an implicit bet that the trends of the last five years will be different over the next five. While an investor might want to make that bet, you also must have a view of how they will be different in order to make a rational fund choice. If an allocation to alternatives is something you think you need, a significant amount of due diligence is needed to try and find both the strategy and specific fund that will be additive to your portfolio’s risk-adjusted return profile – a job that is difficult given the short track record of many alternative strategies.






Published by Gemmer Asset Management LLC The material presented (including all charts, graphs and statistics) is based on current public information that we consider reliable, but we do not represent it is accurate or complete, and it should not be relied on as such. The material is not an offer to sell or the solicitation of an offer to buy any security in any jurisdiction where such an offer or solicitation would be illegal. It does not constitute a personal recommendation or take into account the particular investment objective, financial situations, or needs of individual clients. Clients should consider whether any advice or recommendation in this material is suitable for their particular circumstances and, if appropriate, see professional advice, including tax advice. The price and value of investments referred to in this material and the income from them may fluctuate. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. Fluctuations in exchange rates could have adverse effects on the value or prices of, or income derive from, certain investments. No part of this material may be (i) copied, photocopied or duplicated in any form by any means or (ii) redistributed without the prior written consent of Gemmer Asset Management LLC (GAM). Any mutual fund performance presented in this material are used to illustrate opportunities within a diversified portfolio and do not represent the only mutual funds used in actual client portfolios. Any allocation models or statistics in this material are subject to change. GAM may change the funds utilized and/or the percentage weightings due to various circumstances. Please contact GAM, your advisor or financial representative for current inflation on allocation, account minimums and fees. Any major market indexes that are presented are unmanaged indexes or index-based mutual funds commonly used to measure the performance of the US and global stock/bond markets. These indexes have not necessarily been selected to represent an appropriate benchmark for the investment or model portfolio performance, but rather is disclosed to allow for comparison to that of well known, widely recognized indexes. The volatility of all indexes may be materially different from that of client portfolios. This material is presented for informational purposes. We maintain a list of all recommendations made in our allocation models for at least the previous 12 months. If you would like a complete listing of previous and current recommendations, please contact our office.


Bookmark and Share