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Hedge Fund–Like Mutual Funds Lose Appeal as Investors Pull Out

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The lure of liquid alternative funds

Following the 2008 global financial crisis, normal investors who had lost money investing in traditional funds developed an appetite for vehicles whose performance was agnostic to market conditions. This helped absolute-return funds and long-short equity funds attract deposits from investors. In the six years leading to 2014, such strategies attracted more than $250 billion.

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Exodus amid lackluster performance in trailing markets

However, these investment vehicles also tend to use riskier instruments such as derivatives and other illiquid assets. The bountiful cash invested in these vehicles by clients invited regulatory scrutiny into the transparency of these instruments, as well as their compliance with liquidity and leverage rules.

These investment vehicles trailed behind the S&P 500 (SPY) last year. While the S&P 500 posted 14% last year, these non-traditional investment vehicles posted 1.2%. According to Bloomberg data, funds operated by Pimco (PTTRX), J.P. Morgan (JPM), and Goldman Sachs (GS) witnessed redemptions this year. These hedge fund–like mutual funds invited just over $1 billion until May 2015, as opposed to $39 billion during 2014 and a massive $96 billion during 2013.

Costs and performance of liquid alternative funds

According to research by Vanguard, the costs for liquid alternative strategies tend to be higher than conventional investment strategies. A wide range of direct expenses such as sales loads and expense ratios, as well as indirect costs such as lack of identifiable benchmarks and increased complexity, should be kept in mind by investors who wish to invest in these vehicles.

Although certain alternative fund strategies tend to perform better in specific environments over the short term, their performance over the longer term spanning across both bear and bull equity markets is less clear.

Performance of alternative strategies in 2015

With relatively slower gains in the stock market and relatively high levels of volatility in global markets, alternative strategies have been performing relatively better. For instance, the HFRI Fund Weighted Composite Index, despite its decline in June, outperformed the S&P 500 Index (SPY) by more than 2% during 1H15.

In the next part of this series, we will analyze the recent trend of consolidations in the energy industry by players such as WPX Energy (WPX), which recently announced an acquisition deal.

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