nisiprius wrote: ↑
Sat Nov 18, 2017 12:56 pm
I think the chief argument for "alternatives" is:
- Unless something is different from traditional securities (stocks and bonds), it can't be better than traditional securities.
- Alternatives are different from traditional securities.
- Ergo, alternatives are better than traditional securities.
The point is not to get something better than traditional securities. The point is to get something different from traditional securities, even if it's worse on average*, so you don't have to bet as strongly on the best options. It's an MPT-style diversification argument.
*hopefully it's not worse, but getting a positive Sharpe ratio after fees and costs in a market neutral fashion is a real challenge already and in some models and understandings shouldn't even be sustainable at all, so you'd better not expect too much more
A lot of alts are not market neutral. Some are long non-stocks-and-bonds exposure, like for example CCFs. Some alt strategies have significant market betas because of underlying holdings, not shorting out market exposures, etc., and in this case what you need to evaluate is the performance of the non-market-related component.
nisiprius wrote: ↑
Sat Nov 18, 2017 12:56 pm
Something that Rekenthaler didn't talk about, and I think he should have, is that most of Vanguard's funds are long-only portfolios. They are just bundles of securities. I think the same is true of DFA.
But, for reasons I don't completely understand, all of AQR's funds that I've glanced at are long-short portfolios with leverage. Traditionally, mutual funds are supposed to be strictly limited as to how much leverage they can use, but apparently it is OK to get around that by using derivatives. I don't know if there is something about "alternatives" that makes this necessary, or if it's just AQR's way. It's not surprising
that AQR does this, because Cliff Asness and AQR comes from the world of hedge funds, which have no such restrictions. Financial sophisticates almost always seem to use leverage, and always have very good arguments as to why leverage isn't dangerous if you know what you're doing, and why the particular way they
are using leverage isn't a problem. But I don't like it.
AQR runs a whole lot of long-only equity funds that are unleveraged, funds outside the alternatives category. The issue is that they're basically just boring factor funds, and AQR charges relatively high fees compared to what others do in this space. And performance hasn't been anything good in the relatively brief histories (single digits years), in part from some bad luck (certain factor definitions and construction methodologies doing worse than others over a given period) and also of course the underlying factor returns. But also because they're not really doing anything special there.
All the competitors pursuing similar alternatives strategies use derivatives, etc., many using leverage depending on the circumstance. As for the derivatives, these are the only ways to access certain investments, and they're a cheaper way of accessing other investments (for example, for trading the S&P 500 or other equity markets). A managed futures strategy is going to use derivatives because those derivatives are kind of in the name, right? More meaningfully, you can't trade a lot of those underlying products without derivatives, so that's why they are used. Worry more about strategies, not the tools to implement those strategies. Now, the implementation details also matter, how the trading is done, positions sized, trading signals, etc., but getting hung up on the tools is a bit shortsighted. There are a whole lot of arguments you could make against the underlying strategies. Would it bother you if a pension fund getting rid of a submanager for an equity sleeve moved the equity exposure into equity index futures temporarily before finding a new manager?
Outside of of the strawman field, everybody understands that leverage increases risk and can go wrong, but it's just a tool. You can use it to take too much risk, and you can use it in other ways too. It matters what you're leveraging. 2x leveraged short-term Treasuries is a lot less risky than stocks. A 30/70 portfolio leveraged 1.5x is less risky than stocks and is probably better diversified in a meaningful way (also likely to return less). A 2x leveraged stock portfolio is asking for a lot of trouble. So it really depends.
There are substantial risks in a lot of different alternatives strategies, especially the AQR funds highlighted. After all, if you can return 10%+ in a year in a market neutral way, you can easily lose that much and more just as quickly. They're clearly riding a lucky hot streak in some of these funds. The question is what to expect in the future.