Maybe it takes a swooning stock market to focus the mind on alternative assets, a category that most people ignored over the past few years as share prices soared to new highs. But following the recent stock market plunge, alternatives, which have little to no correlation with the stock and bond markets, are looking more appealing.
Consider what occurred during the summer slump. Standard & Poor’s 500-stock index plunged 11% between August 10 and August 25. Over the same period, managed futures mutual funds, which use futures contracts to track trends in various markets, nearly broke even, on average. And market-neutral mutual funds—which seek to reduce risk by offsetting stock holdings with roughly equal positions in stocks that are sold short (a bet on falling prices)—lost just 1.2%, on average.
How much of your portfolio should you devote to alternatives? Chris Geczy, an adjunct professor of finance at the University of Pennsylvania’s Wharton School, suggests at least 10% of your assets, which should provide some cushion when the stock market tanks. With alternatives, “you may not make as much during a bull market in stocks, but you won’t see the same declines, either,” he says.
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The mutual fund industry has produced a slew of alternative offerings in recent years. The category includes a hodgepodge of diverse strategies, so choosing the right one is key. Morgan Stanley says that multi-strategy alternative funds, managed futures funds and market-neutral stock funds make sense now.
In the first category is IQ Hedge Multi-Strategy Tracker ETF (symbol QAI), an exchange-traded fund that tracks an index of six alternative strategies. Altegris Futures Evolution Strategy N (EVONX), a mutual fund, combines managed futures with an actively managed bond portfolio. A rise in takeovers enhances the appeal of merger funds. They typically buy stock in a targeted firm after a deal is announced. We favor the aptly named Merger Fund (MERFX), a member of the Kiplinger 25. Finally, consider TFS Market Neutral (TFSMX), which invests mostly in small-company stocks, maintaining a market-neutral stance by holding an equal ratio of long and short positions.
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