With 1,000 point swings in the Dow and problems in China – the pressure is on for the hard working folks in the alternative space. For the past five to six years, alternative assets have been exploding; growing in part because many of them promise non correlated performance to stocks and bonds – meaning, they look to provide diversification in your portfolio when the market finally takes a turn lower.
Well, for really the first time since the financial crisis, the market (as if there’s only one) is showing signs of turning. There was the Dow down 1,000 points, and equity markets overall down around -10% from their highs, entering “correction territory” as someone arbitrarily labeled it long ago. In baseball terms – you put a knuckleball hitter on the payroll a while back, but he’s yet to see the field. Now, finally, you are going up against a knuckleball pitcher, and get to see just what you’ve been paying for.
This is looking like the first time in a long time Alternatives are going to be asked to carry the load, and we can’t wait to see where the August dust settles in the coming days/weeks. We did our best last week to highlight a couple of managed futures managers that captured the market volatility, but we’re also hearing stories of big firms like Transtrend having had a tough go of it during the spike in volatility. And that’s just in the managed futures space…. What type of number will everyone’s favorite alternative, long/short equity, post on the scoreboard for August? What about private equity? And don’t even get us started on real estate and commodities, the latter of which has famously led this move lower.
Now, we’re well aware that it’s just one month, and that even those alternatives who lose money are likely to do it in a less volatile way than pure stocks. But this really comes back to why investors bought an alternative and what they are expecting out of it. If they’re expecting negative correlation (often times conflated with non-correlation), they may be disappointed with their Alternative investment. In the case of Private Equity, Long/Short Equity, Commodities, and Real Estate – there’s nothing you can really do about that. Those investments tend to be highly correlated to equities, especially in times of market stress (see our whitepaper or infographic for more on that)
If you’re talking Global Macro and Managed Futures, it’s a little trickier. You see, those tend to be negatively correlated to stocks in times of market stress; but not necessarily at the moment of max stress (like the crazy Aug 17 to Aug 24 week). They tend to require some follow through on the downside, where five weeks of stock market losses might see managed futures lose in the first two and make money in the last three. What’s more – those programs which are more heavily geared towards financials (stocks, bonds, currencies) can see outsized effects from bouts of volatility in stock indices; as they have less protection via diversification into multiple asset classes, and can see problems exiting positions in a crisis as everyone rushes for the same exit.
So, we’re nearly as excited to see the August numbers as we are for football season (nearly… not quite). It will certainly be an interesting couple of days as we watch returs roll in for asset classes and individual programs. Did hedge funds lose money (yes), and we’re bound for a whole new slate of S&P and hedge fund performance comparisons. Anybody blow up? What type of exposure did they have? What about for the “Managed Futures” category of Mutual Funds in Morningstar? What was the dispersion in August returns there? What about trend following strategies compared to the short term traders and relative value traders?
This isn’t to say this is how your alternatives will perform during a full on, months long actual crisis; but it’s certainly a good time to pay attention to why alternatives investments are performing the way they are. It’s time to see what that knuckleball hitter you’ve been paying to ride the pine can do in the real game. Put me in coach!