Gillian: Welcome to Asset TV. I’m Gillian Kemmerer. Liquid alternative funds have been getting a lot of press lately but what are they and where do the opportunities lie? Here to help us understand more is Stacey
Russello, she’s the President and Portfolio Manager at Sirius Fund Advisors. Stacey, thank you so much for joining us.

Stacey Russello: Thank you having me, Gillian.

Gillian: Of course, our pleasure. So let’s get started with the definition, what is a liquid alternatives fund?

Stacey Russello: Liquid alternative funds are a fascinating investment tool. They have grown a lot over the years but more recently have gotten a lot more focus and this is because they are answering a need that has become obvious in the investment world. And in general that need comes up when you’re looking at a traditional portfolio and you’re looking at a client holding equities and holding fixed income, a mix of that, possibly some defensive securities, help deal with the market changes in any given market day. But in general this portfolio is positioned for the market to rise. And as long as the market’s rising you have a portfolio that is advancing and achieving returns, and that’s great. When a market pulls back and the portfolio value starts to pull back as well, that’s not so great. And a lot of portfolio managers would like to diversify this market risk in their portfolios for their clients. So what they are doing is taking a look at how do I find an investment vehicle that will solve this issue, that allow us to diversify the portfolio and reduce exposure to market risk or potentially the portfolio has exposure because it’s investing for client wishes in a certain type of asset in the market. And they need something else to balance this out that is also going to deal with changes in the market performance. So to answer this, a lot of people would look at hedge funds; traditionally that’s what’s been available as an alternative investment.

They have alternative investment styles that are very unusual, very specific, somewhat broad. But they also come with a lot of restrictions. And these restrictions can keep people from investing in those funds. The restrictions are generally capital restrictions; it’s not a liquid investment. In general in hedge funds you’ll invest for a period of time and that capital must stay in for the initial period. And after that the capital can be withdrawn off at certain periods of time when it’s allowed, when the fund is planning for having liquidity for that purpose. So it doesn’t always fit the portfolio need and then the additional restriction you’ll find in a hedge fund is that certain investors have to have qualifications. You need qualified investors that meet standards defined by the Investment Act to be in these funds. So they typically are restricted to high net worth individuals or institutional investors. And they’re a great tool for the people who can qualify for them and who can meet the restrictions. But it doesn’t always fit in more of your everyday investor, your average investor really people. They need something that’s more liquid that can help balance their portfolio and diversify risk of how their portfolio is invested. And that’s where liquid alternative funds come in; they are a fund that is designed to be liquid, which doesn’t mean their holdings are necessarily liquid. What it does mean is that an investor can move in and out of shares in this fund with ease, hence liquidity, are similar to a mutual fund or an ETF.

These funds are … liquid alternative funds are mutual funds, ETFs and closed end funds. So that is the structure we will see. There are advantages to both mutual fund, you’re looking at buy and hold more than likely. The mutual funds are going to exit and enter at NAV. An ETF can trade intraday, so it’s more like a security. And closed end funds, again more like a mutual fund. And that is the general structure of the funds and the popularity has grown because they are bridging a traditional investment style with non-traditional style or a hedge fund type style. These are more like liquid hedge funds.

Gillian: So that was really helpful in getting us to understand what the structure is. But what do liquid alternative investment funds actually invest in?

Stacey Russello: Now, that’s a very big question. The liquid alternative fund space is broad. This is a huge market with all different types of investment objectives. And that’s what makes it hard to define what is a liquid alt, because it is so much, it can be a very narrow focus to a very broad focus. So really it’s better to understand what the concept for a liquid alt fund is to understand what they’re holding. In general some of the funds may have a traditional investment approach, but they take that a step further and use something beyond a traditional investment such as using leverage or going short or a tactical allocation, moving completely in and completely out, which is not usually used in a traditional approach. They can target market performance. We want to have larger than market returns in an advancing market. Or we’re looking at more of a bear structure, let’s have returns in a bear market or a pullback, or a lower beta where we just want consistent returns that are not large but are consistent and there and reducing risk, reducing volatility. So you can have multiple structures that solve those issues. And then you can have a narrow focus where they look at a specific asset class or a specific sector. And that focus ignores the rest of the type of market.

An example would be biotech sector or tech sector, something of that nature, or you can have a theme or somebody wants … I only want to invest in companies that have socially responsible activities. So you look for a fund that would have that kind of theme, it may go across multiple sectors but you’re answering a need that a client wants. And there will be a fund that will address that. You’re going also looking at asset based funds. Somebody wants a real asset behind it; they don’t want other investments, so you’re looking more at real estate or commodities in those types of funds. So this really does span the breadth of the market, depending on what the goals are for that fund and the goals for the fund that resonate for what someone wants to achieve for a client in their client portfolio. So this is a large area. In general to characterize what is in a fund we can look at two different types of strategies that help understand what would be in there.

One is the asset class strategy where the fund is being tagged to a benchmark and the idea is for the fund to perform similarly to this benchmark or outperform the benchmark. And the objective is very specifically stated. So it’s well understood if they’re following this benchmark that has this mindset in the fund, again technology is a great one to use, it’s a tech fund. Another one is the investment strategy and this is where you have more of the portfolio management where they’re using portfolio management styles, alternative styles, if you will, to manage the portfolio away from a traditional method. And that would be something like a tactical allocation where it’s fully in, in certain markets or in defensive mode in other markets, or use of leverage or use of shorting. You have that active management component, that alpha component in the fund. So those two are the main areas that I have seen that the funds tend to operate and help an investor understand what is going to be in this fund. Because again this is a very broad market, so defining it is going to really be specific to the funds that are being considered.

Gillian: So why would I consider a liquid alternatives fund to add to my portfolio?

Stacey Russello: Well you would consider this to diversify risk in a client’s portfolio. And client portfolios have a lot of guidelines. They have restrictions, the clients have certain pet projects they like or certain investments that appeal to them. Investment styles, levels of risk etc, it’s very broad for what a client would like to achieve in their portfolio. And it’s not always a well balanced approach that’s going to perform well in multiple markets. Clients, they have their specific objective. So how would you diversify the risk in a portfolio for a client that doesn’t have a broad exposure to the general market? So it’s not necessarily diversified across sectors or asset classes or for market performance. And that’s where a liquid alternative fund would come in. You want to look at a fund to see how this would fit in a client’s portfolio. And a good example is at the end of last year, the market pulled back in a sharp pullback and then again in February. How many people were happy with how their traditional funds or traditional investments were holding up, how the client portfolios were performing? Certain sectors were hit harder than others. How did that go?

And then the market earlier this year went up then went into a trading range. So now it’s difficult to achieve positive returns because the market’s stuck in a trading range. So if you’re not satisfied with how the portfolio is going, you’re going to want to look at different investments. And liquid alternative funds are an excellent tool to achieve that goal. You can diversify the market risk, a range bound market; there is a fund that will handle a range bound market. There are funds that will handle a market that might pull back or go through a correction again, more of a bear strategy. There are funds that are positioned to outperform in a risking market or to try to perform in all of those markets. There are also funds that deal with asset class specializations or theme specializations. You can balance this out with another liquid alternative fund that can give more even returns to the portfolio and help ease the client’s pain while the client’s pursuing their goals for their portfolio, and something which just makes sense to provide returns and provide good portfolio performance. It’s a great way to diversify multiple types of risk; again there are so many funds. It’s probably fairly easy to find something that will add value in a client’s portfolio.

Gillian: So you touched on this a bit earlier but I want to come back to it, what is the risk profile of a liquid alternative fund, generally speaking?

Stacey Russello: Well, liquid alternative funds have more risk in general. This is because the funds are employing alternative investment strategies. So they’re relying on something that’s not more based in a broad market and is not based in a traditional market. And so this does elevate risk, in general you have risks identified by asset class, the funds themselves could be specializing and that’s why it’s being added to a client’s portfolio, to meet a need or a client’s goal. And the specialization can keep it in the sector that is going to underperform the broader market. So from this perspective it is riskier. And people investing in the fund should understand the risk that applies for that particular fund. You also have the underlying investments in a liquid alternative fund. And this is a bit of a misnomer; liquid alternative funds refer to the structure of the fund and the ability of an investor to come in and out of that fund. But it does not mean the underlying investments are necessarily liquid, so that is an important distinction, it does carry risk if a fund is holding less liquid assets in it. Now, clearly the fund manager will be planning for redemptions and contributions for that fund and will plan accordingly for cash flow purposes. But it is important to understand that some of them may hold investments that are not as liquid and not as easily moved in and out of in that fund, which will increase risk.

And the last part would be the investment strategy. Investment strategies that have a tactical allocation for example, could be fully in the market and then pull fully out. So there is a risk, if that timing doesn’t gel with where the market’s performing, there’s a potential of lost returns or a potential that it was pulled too late. And returns did not perform as expected. So these are things that need to be assessed when looking at the funds. Funds also use leverage; they take short positions, again tactical allocation. So as always being unleveraged carries additional risks. Being short carries additional risks, and these are something that require careful consideration for each fund in how the funds are going to perform. Now, something else to consider in the liquid alternative arena is that similar funds with similar goals don’t always behave a similar way. Sometimes the risk between those funds is different because of the investment management style or how the objectives are occurring during the portfolio’s investment program. So even though multiple funds can be compared by their objective, they may have different risk profiles. So it is really important that someone consider these risk profiles in a client portfolio and determine how the liquid alt fund could add value to the portfolio and what’s appropriate.

Gillian: So, Stacey, how do you find the right liquid alternatives fund?

Stacey Russello: Now, that is a great question and I’m going to answer that with another question. How do you know what problem you need to solve? And I’ll use the word ‘problem’, because if you’re looking at additional funds to add to a portfolio, in general you have an objective that you want to meet for that portfolio. You’re aware that something’s going well, but maybe not quite as well or there’s an exposure you believe is coming, should be addressed now or it hasn’t gone well and you want to solve that problem for your client’s portfolio. So what’s needed in the portfolio? And I think that’s just as important as saying, “Well, I want to add something to the portfolio.” You need to understand what you want to add. Now, as far as how to select that fund, and we’ve all the heard the story about the monkey that threw darts at a board and picked investments and that investment portfolio outperformed some well known portfolio managers. And I cannot recommend that for choosing your liquid alternative fund. I think in general you want to look at the pain points for the client’s portfolio or again, how it has performed. Are you looking at market risk? Is this a diversification to deal with a market that’s ranged bound, that’s pulled back and has volatility or has no volatility? Or is this more my client wanted to invest in a certain sector or a certain asset class, and we want to balance a portfolio a little better and be able to even out returns, not have so much sector risk.

So these are great ways to identify the problem. And a lot of people are going to say, “Well, let’s go ahead and look at performance. Let’s get these liquid alternative funds and let’s look up the best ones and make a list.” Well, that’s a great idea. But are those funds actually addressing the weaknesses in the portfolio? Do they fit in and add alpha to what you’re trying to do with that client’s returns? So it’s key to understand what points need to be addressed and what can benefit that client’s portfolio. And that will help define what type of funds do you want to consider for the portfolio? And then again you have to do your due diligence on what the funds invest in. What are the underlying investments? What is the investment style? How has it performed in the markets I am considering, just to be sure it fits well with what my objective is? And again, what were the drawdowns? We’re there investments in that portfolio that were less liquid and the fund didn’t do well when there were drawdowns? You want to be aware of that risk before a step to invest is taken. But in general I think the liquid alternative market again is so broad, there are so many options that can address different types of risk in a portfolio that there is a selection to help achieve the client’s objectives.

Gillian: So why was Sirius Point Advisors started, and then the Sirius S&P Strategic Large Cap Allocation Fund, why was it started as well?

Stacey Russello: We started for the same reason; a lot of people are looking at the liquid alt environment, is that we felt this fund had something to offer. Has something to offer client portfolios. We came from a very humble beginning where we were using an index based investing style as a fund of funds. The index we followed was the S&P 500 and we would make investments in S&P 500 mutual funds in a tactical allocation method, looking to invest when the market is going to go up in the medium to long term time horizon. And looking to be out and preserve capital in defensive mode if we felt the market was going to pull back. And this is the investing style that I find seems to fit with most every day investors. If they have a choice they’ll say, “I’m going to invest low and I’m going to be invested long term and get my appreciation in the market, get my returns as the market rises.” And then you know when it’s going to turn and be difficult or volatile or a pullback correct, I’m going to pull in defensive mode and preserve that capital and keep that there for my next window. And I assume people are like us and that this is a good fit. But I also saw that we could do more if we had more tools at our disposal, leverage and shorting. So we wanted to take tactical allocation and add the ability to leverage and the ability to short to it, to put together a fund.

So then the key element for this type of investment is how do you know when the market’s going to turn? We’re a very technical analysis group, and how do we know? My first choice would be to get that perfect crystal ball that’s going to say the market’s going to turn right now. But unfortunately I’m still waiting. What we do have instead is the family over the years developed a risk rating system. And this is a system that we calculate every day after the close of the market, with predominantly publicly available market information. And this information is calculated across several different custom rating figures to assess the risk versus reward potential in the movement of the market. And again this is technical, so I’m looking at patterns in the market and how the market has moved. From there it gives us a medium term to long term rating about where we think the risk versus reward is for a rising market or for a declining market. And it will tell us the difference. And this has been a wonderful tool for understanding when the market might turn and when it’s a good time to take a good look at the portfolio and when I should be making a decision about how that portfolio is invested and what the next step is. And we’ve been very pleased with how the fund has done; we’re enjoying the liquid alternative space. I just think there are a lot of opportunities in this type of funds for how they can add value to the clients’ portfolios. And we are looking forward to the opportunities to our fund in the future.

Gillian: Well, Stacey, thank you so much for taking the time to share the landscape with us and then to tell us a bit more about Sirius Point.

Stacey Russello: Thank you very much.

Gillian: Of course. From our studios in New York, I’m Gillian Kemmerer, thank you so much for tuning in.