Funds for Alpha in Bull and Bear Markets

05/28/2012 7:00 am EST

Focus: ALTERNATIVE INVESTMENTS

Altegris executive vice president Dick Pfister tells MoneyShow about three of his company’s alternative-strategy mutual funds, and explains why these funds differ from long-only instruments, which are more highly correlated to general indices.

Kate Stalter: Today our guest on the Daily Guru is Dick Pfister of Altegris.

Dick, your company has a number of alternative funds, so maybe today we can start with the 30,000-foot view. You can tell us about the funds briefly—about your company, how it was formed—and then we can drill down a bit into some of the funds themselves and what they are.

Dick Pfister: Sure, thank you for having me on. I’ll give you the brief synopsis of who Altegris is. I’m one of the founding partners of Altegris, and the core group of Altegris has been together for nearly 15 years.

We oversee about $4.5 billion of total assets under management. Most of that money, historically, was allocated to hedge -fund and managedfutures managers in a limited partnership format, which has certain net worth requirements and liquidity issues.

But over the past three years, we‘ve been taking blue chip, best-of-breed, hedge-fund and managed-futures managers that were only available in that format, and we‘ve put them into mutual fund format, which means they have much more transparency, much more liquidity, and it reaches a much wider investor base than we had historically.

That’s been an evolution in the alternative landscape that’s been growing, and growing over the last two to three years, as we refocus a lot of our efforts and some of the funds that we’ve recently launched over the last 24 months.

Kate Stalter: Let’s talk a little bit then, about some of these specific funds. I understand that one of them is the Altegris Managed Future Strategy Fund (MFTAX). Maybe you can start out with that one.

Dick Pfister: Sure. That’s a fund of ours which has got about $1.1 billion in it. It was launched about 23 months ago. It has six managed-futures traders in it, and we serve as the investment advisor for that mutual fund.

What we do is, we allocate to managers who, historically, have only been available to accredited investors or super-high-net-worth investors in a high minimum context. Some of these managers, to access them historically, you had to put $10 million or $20 million individually with each of these managers.

We took those managers that we have been working with for over a decade in that format, and formed a 40 Act registered mutual fund, and then allocate to six of them. So the managers, even though our mutual fund track record’s only about 22 months long, the underlying managers have over a decade-long length of track record.

And the reason it’s been so successful in gathering assets in this space, is because the investors know that the quality of the underlying manager is the highest of caliber. And now they’re able to take $2,500 minimums, $5,000 minimums, and allocate across their advisory practice into this particular strategy, and individual investors are able to buy at the same type of minimums as well.

Kate Stalter: Let’s talk just for a moment, before we move on, about why would individual investors be seeking this kind of exposure within their portfolios? Perhaps to replace, or in addition to, regular equities or fixed income? How would this fit?

Dick Pfister: Sure, what we‘ve seen in the investment landscape, at least over the last ten years and actually over the last 15 years, is long-only stock purchasing and mutual funds has been virtually flat. The equity markets have gone pretty much nowhere.

But you’ve had a lot of volatility over the last ten years. You had the tech wreck in the early 2000s. You had the credit crisis of 2007 and 2008. You have this uncertainty that’s surrounding the European sovereign debt issues that are going on today. In those types of what we call “crisis events,” strategies like managed futures or long/short equities have done extremely well, versus the long-only side of the business.

So in the tech wreck, the managed futures industry—or asset class—made money throughout those three years of 2001, 2002, and 2003. The equities market, as everybody remembers, was down 40% to 50% through that period. And then again in 2007 and 2008, when the equity markets were down about 50%, managed futures was up anywhere between 15% and 20%.

So they served really as a great buffer for the individual investor who’s traditionally only been accessing long-only strategies, like long-only stocks, long-only real estate, or long-only commodities. So they’re very uncorrelated to the traditional markets that most people access. Thus, they’re getting much more attention, because people are looking to have a much less volatile portfolio in general.

Obviously, we‘ve got the baby boomers coming to retirement. They can’t suffer 50% losses anymore, because they don’t have the time to hold on for the next 15 years to make back that money.

Continued…

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Kate Stalter: Let’s talk a little bit about a couple of the other funds, then. I understand that there is a long/short equity fund?

Dick Pfister: Yes, we just launched a Long/Short Equity Fund (ELSAX). The critical component of what a long/short equity strategy does is, it can participate in the upside of the equities market.

The managers we have in this fund are managers that have been trading in the equity space for a decade plus, so they can ride the upside of a market. But the real important part is that they can either step to the sidelines and go to cash, or go short individual securities if they think the market is going to go down.

And that’s a very vanilla concept, I think, in general. You’re getting exposure to the equity space, so you don’t have to, hopefully, give up a lot of the upside if we do have a run.

This particular type of strategy can do well in sell-offs. So over this last month, we’ve actually lost half as much as the equity markets have, and we’re attempting to capture at least two-thirds of the upside of what the equity markets do if they continue to rally.

Kate Stalter: Now there’s another one here I wanted to ask you about that sounded pretty interesting: the Futures Evolution Strategy Fund (EVOAX). From what I‘ve read here, you’re working with DoubleLine on that one? Talk about that.

Dick Pfister: That’s an interesting fund for us. It combines two legendary managers. On the managed futures side, we’ve allocated to a firm named Winton Capital Management. They’re widely regarded as the best-of-breed managed-futures trader in the world. They manage just under $30 billion total assets, and when you allocate to the mutual fund, you get exposure to that manager in the managed futures world.

But then with the excess cash—we call it the “excess margin” in a managed-futures strategy—we’ve taken that and we’ve allocated that to DoubleLine Capital. And DoubleLine Capital is headed by a trader named Jeffrey Gundlach, who’s very famous. Barron’s called him the next “king of bonds” right after Bill Gross, and he’s been delivering great risk-adjusted returns in the fixed-income world.

So, with this particular fund, the Altegris Futures Evolution Fund, you’re getting exposure to a blue-chip managed-futures strategy, as well as a blue-chip fixed-income strategy, and that fixed-income allocation will give you yield as the other component of what this strategy does. And then the managed futures component gives you that non-correlative return stream that we were talking about. So it’s a really nice marriage between two different types of strategies.

Kate Stalter: One thing that I often discuss when I talk to alternative strategies managers is: Investors get concerned sometimes when they see some of the expense ratios that are associated with some of these funds. Is that something to be concerned about here, or is there something more that perhaps people should know when they look at these ratios?

Dick Pfister: Yeah, I think when you look at traditional mutual funds—let’s call it a value fund, a growth fund, a tech fund—what those funds are trying to do is beat a relative return benchmark, and that might be a value index, the S&P 500. It might be the Nasdaq.

Those strategies are trying to get you exposure to the underlying securities in those indices, and hopefully slightly outperform. But if the index is down, let’s say, 20% on the year and those strategies are only down 15%, on a relative basis they’ve done better. But on an absolute basis, they’ve still lost money.

In our opinion, when you’re allocated to those types of strategies, you should go for the lowest-cost option. You can try to get an ETF in that, you can go to the suites of Vanguard-type funds, which have very low expense ratios. And that is a world where we call: You have a lot of beta to the market.

Where we come in, in the alternative space, is we are trying to produce alpha, uncorrelated absolute returns, in bull and bear markets. When you can deliver that, you should be able to get great net returns after all fees.

The managers who trade in those types of strategies are trading on a much more active basis. And because they trade in a much more active basis—long and short equities, long and short currencies, long and short commodities—they demand a higher fee.

So, the expense ratios on these funds are typically 150 basis points, maybe 200 basis points per year, 2%. It’s higher than the long-only world that most mutual-fund investors have lived in.

 For us, that’s part of what we need to do: Educate people on the differences between what an alternative mutual fund does and what a long-only traditional mutual fund does. At the end of the day, the net returns, net of all fees, is what the investor should be looking at, and if they’re delivering good, risk-adjusted net returns, that’s our goal.

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