Even as the U.S. Federal Reserve Bank (FED) has begun to raise interest rates, the markets are still in a low-interest-rate environment. Especially for Europe, some experts expect these conditions will stay around longer, even though the European Central Bank (ECB) is starting to speak about tapering. Because of the low interest rates, more and more investors are looking for alternatives, especially if they need income from their portfolios or want to bulletproof their portfolios against rising rates. In the past investors were willing to accept higher risk from issuers and/or on the duration side, and they invested in high-yield bonds or bonds with a very long duration to generate higher returns. But even these strategies don’t pay off fully anymore; since spreads have in some cases come down so far that they don’t reflect any longer the risk from the issuer. After the initial rate hikes by the FED long duration also does not seems either not to be the right answer anymore.
Within this environment it is not surprising that investors start to focus on alternative UCITS funds, since these products seem to be the product of choice in an environment like this, as they often promise to generate returns in all market environments. With regards to this, alternative UCITS are often also considered as “hedge funds light”, which is obviously wrong. Even as a number of products in this sector do imply hedge fund strategies such as long/short equities or global macro approaches and/or modern portfolio management techniques, these are often exposed to market beta. In rising markets this is not bad for the funds since the tide lifts all boats, but they have to prove their ability to avoid losses during rough market conditions.
The year 2016 showed that not all funds deliver on their promises. This means investors have to look very carefully at the strategies and techniques used by managers of alternative UCITS funds if they want to use this kind of fund as a bond surrogate or to bulletproof their portfolios against market disruptions.
That said, it is not bad for an alternative UCITS fund to have some market exposure, since this can help to improve the return of a strategy. But investors have to take this into consideration when they build their portfolios. They must estimate the overall downside risk to their portfolio. On the other hand, there are also funds available that have only limited market exposure and might therefore be a better choice, even though they show lower returns in rising markets.
From my point of view alternative UCITS funds can be a good alternative for investors who want to use this kind of product as a bond surrogate or as an alternative source of return in their portfolios. But they have to select the products very carefully; not all funds–even those within the same peer group—have the same investment objective and may follow different investment strategies. These even small differences can, especially during rough market conditions, lead to totally different results. Investors need to use a proper fund selection process to select those funds that really fit their needs and expectations and should not simply buy an alternative UCITS fund just because of its past performance.
The views expressed are the views of the author, not necessarily those of Thomson Reuters.