If you’ve attended as many advisor conferences as I have, you know that panel discussions featuring speakers whose firms have booths in the exhibit hall are rarely more than a “pitch fest” – an opportunity for panelists to promote their firms’ strategies. However, a panel on alternative investments at the Pershing conference last week was an exception.

Get The Full Hedge Funds Series in PDF

Get the entire 10-part series on Hedge Funds in PDF. Save it to your desktop, read it on your tablet, or email to your colleagues

Ray_Dalio_JPG ValueWalk Bridgewater associates How the economic machine works

AnandKZ / PixabayThe panel featured three speakers: Scott Henderson, a senior vice president and portfolio specialist with Calamos Investments, who specializes in convertible securities; John Simmons, senior investment strategist with William Blair and part of its global macro team; and Marc Dummer, managing director and portfolio manager at Principal Portfolio Strategies and a specialist in low-volatility solutions.

The panel discussion took place on June 14 as part of the Pershing INSITE conference, held in San Diego.

What is driving advisors to use alternative solutions?

Following the global financial crisis there was a rush from “two-and-20” providers – hedge funds – to bring those structures to the “liquid space,” including mutual funds, according to Henderson, and advisors are seeking the risk-protection plus upside potential offered by hedge fund vehicles. Dummer said that beta does best when rates are falling and correlations are high, rising rates and low correlation favor active strategies, but alternatives do best with there is speculation and diversion, which he said characterizes the capital markets now.

The question advisors should ask wholesalers is what problem an alternative vehicle is solving, according to Henderson. All alternatives behave differently in different environments. The main “buckets” into which alternative solutions can be categorized are return generation (such as long-short equity), diversifying assets (such as managed futures) and risk dampening solution (such as low volatility), according to Simmons.

Three sources of return from alternatives are the risk-free rate, beta and alpha, according to Dummer. For example, he said that a “good” low-volatility strategy combines the risk-free rate and alpha, but produces a very low beta.

Simmons said he employs multi-manager solutions since his firm is focusing on alpha, and because the biggest risk is manager skill fading or a manager leaving. He said it is common for only two out of three managers within his solutions to be “working” (performing well) at a given time. Dummer said you need eight to 10 managers to get rid of manager-specific risk. If you get to 20, he said, you have a beta product.

Simmons said his firm also uses active currency management and said that discipline is largely lacking among U.S. investment management programs. He said currency management has a bad reputation, but his firm uses a unique approach that is independent of its equity and fixed-income exposures. Dummer said that in the currency space, global equity managers tend to have little currency exposure – but that currency is an asset class that can be managed.

Dummer said that what you reduce in your allocation to accommodate an investment in alternatives depends on your desired outcome. If you are looking to reduce market exposure, then a market-neutral fund might be the best solution to replace equity exposure. Most advisors, Henderson said, are worried about fixed income. He called the U.S. bond market a “high-yield market on a global basis,” in reference to the low interest rates on non-U.S. sovereign debt. Dummer said that advisors who want stability should distinguish that need from the need for income.

By Robert Huebscher, read the full article here.