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Funds for Uncertain Times: Alternative Funds

How do you invest in uncertain times? Many investors these days are looking for new ways to mitigate risk and navigate today's low interest rates.

To help, we’re taking a closer look at mutual funds that could help in uncertain markets, and we’re starting with alternative funds. You'll learn:

  • What is an alternative mutual fund?
  • What are examples of alternative investments? 
  • Who can buy alternative funds?
  • How might alternative funds help investors in 2020?

FundX advisors answered these questions and more to try to help you get up to speed with alternative funds. 

What are alternative funds?

Alternative funds aim to be an alternative to traditional stocks and bonds. These funds may own alternative assets, such as precious metals, real estate, or currencies, and many funds use hedge-fund-style investing strategies, such as long/short or merger/arbitrage strategies.

In short: “Compared to a traditional mutual fund, an alternative fund typically holds more non-traditional investments and employs more complex trading strategies,” FINRA, the financial industry regulatory authority, explains

Alternative funds generally are less correlated to the stock or bond markets, so they can provide additional diversification: they may do well when stocks and bonds are down. They also potentially could offer some growth during periods when stocks and bonds are both flat.

Are alternative funds less volatile than other funds?

Not necessarily. Some alt funds are narrowly focused on one asset, like gold or real estate, and these funds can be very volatile at times. Others are designed to try to reduce volatility, and that’s what many investors are looking for these days. 

As the SEC put it, “Many alt funds try to minimize swings in the value of their investments and reduce risks by spreading their investments among different asset types and/or using complex trading strategies.”

Are alternative mutual funds the same as hedge funds? 

No. Alternative mutual funds may use hedge-fund-like investment strategies, but they are registered as mutual funds and regulated as such.

“As mutual funds, alt funds are regulated under the Investment Company Act of 1940, which provides certain safeguards. These protections include limits on illiquid investments, restrictions on borrowings and debt, and the requirement to allow investors to sell their shares at any time. Hedge funds are not required to follow these regulations,” the SEC explains.

Why would I invest in an alternative fund?

Alternative funds generally don’t look very impressive over the last decade, a period when stocks and bonds did phenomenally well. But some funds held up well in March 2020 when both stocks and bonds came under pressure. And given lower return expectations for bonds going forward and the potential for continued volatility in the stock markets, alternative investments could play an important role in the coming years. 

“Demand for liquid alts is expected to keep rising in a world of rock-bottom rates, because they are cheaper than real hedge funds and you can get out of them at any time, unlike hedge funds, which typically have lockups,” Barron’s wrote

Can I buy alternative funds?

Yes. Many people assume that alt funds are only available to high-net-worth investors or investment advisors, but there are many alternative funds that are open to retail investors and readily available at brokers, like Charles Schwab and Fidelity.

Some funds are intended to be used with the help of an advisor. As Barron’s noted, some funds have “high minimums to discourage people from using them without a financial advisor.” Talk to your advisor about which funds may be appropriate for you and where these funds might fit into your investment plans.

What are some examples of alternative funds?

Here are some examples of alternative funds that are available for retail investors. We've chosen to focus mostly on funds that tend to have similar or less risk than the overall stock market. These examples are not intended to be a recommendation. Talk to your investment advisor about which funds are appropriate for you and your investment objectives.

Merger/arbitrage funds

Merger/arbitrage investment strategies attempt to take advantage of short-term pricing discrepancies between a being acquired and the company that is doing the buying. “Merger arbs typically buy shares in the target company and sell short those of the acquirer to hedge their risk,” Barron’s explained

Alternative fund examples: Merger (MERFX), Arbitrage (ARBFX)

Long/short funds

Most stock funds “go long” on stocks by betting that a stock’s share price will rise. But funds can also bet that a stock’s price will decline by “shorting” a stock. Long-short strategies include both long positions on stocks that the manager expects will go up, and short positions on stocks they expect to go down. The short positions act as a hedge against the long positions, resulting in lower volatility than the overall stock market.

Alternative fund example: Salient Tactical Growth (FFTGX)

Non-traditional assets

Some funds invest in alternative asset classes that are typically less correlated to stocks and bonds, like precious metals or real estate. Permanent Portfolio (PRPFX), for example, invests in precious metals, Swiss Francs, fixed income and stocks. Hussman Strategic Total Return (HSTRX) can invest in fixed-income along with utilities, precious metals, REITs, and other currencies. 

Alternative fund example: Permanent Portfolio (PRPFX), Hussman Strategic Total Return (HSTRX)

Multi-alternative funds

Some funds use a combination of alternative strategies and asset classes. Guggenheim Multi-Strategy Hedged (RYMSX) allocates among five alternative strategies including merger/arbitrage and long/short equity; it also may invest in fixed income and currencies. 

Alternative fund example: Guggenheim Multi-Strategy Hedged (RYMSX), IQ Hedged Multi Strategy ETF (QAI).

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