S&P: strong case for unconstrained strategies of Alternative Equity Funds

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Alternative equity strategies are proving they have a place in a diversified portfolio, as absolute return, alternative income, and market-neutral strategies continue to outperform relative long-only strategies in uncertain and volatile markets. This is one of several key findings from Standard & Poor’s Fund Services’ alternative equities sector review released today.

S&P Fund Services’ alternative strategies sector head, Michael Armitage said: “Most of the alternative equity peer groups have shown risk-adjusted returns that are superior to their long-only indices. Given continued uncertainty and increased levels of volatility, investors will benefit from managers that have more unconstrained strategies—especially those that also concentrate on capital preservation. Additionally, we continue to witness stronger institutional quality offerings, which increased the overall level of competition in our peer review.” 

The report covers the release of 38 alternative equity capabilities in equity beta variable, alternative income, market-neutral, and market exposure strategies as part of S&P’s latest review of the sector. One manager received a downgrade, three managers received upgrades, and with five new ratings (three of which were four stars), the peer group is relatively stable since our previous Alternative Equities review in 2010. 

“With global equity markets experiencing significant effects of global macro events in recent periods and the classic “buy and hold” equity proposition failing many investors over extended periods, alternative equity strategies continue to present a strong case for inclusion in a well-diversified portfolio. Market exposure strategies continue to present mixed returns with fundamentally driven strategies outperforming quantitative-based strategies. In addition, market-neutral strategies have impressed and offer further diversification for investors,” said Mr Armitage. 

Some of the key findings from the sector review: 

  • Investors were cushioned on the down side with help from the flexible mandates of the variable beta peer group managers that are continuing to show their strengths since our last review.
  • The equity income sub-peer group impresses us as a product that is underappreciated as a potential core allocation for income-focused investors.
  • The three market-neutral trading strategies proved their worth as “alternatives”—showing alpha and avoiding significant drawdowns in negative equity environments—demonstrating effectively the portfolio diversification potential of the format.
  • Teams and processes with multiple sources of alpha generation continued to score higher relative to peer funds (despite the fact that some may have shown poor performance contribution from one or more of these particular sources over the period since our last review, e.g. active currency positioning).
  • Incremental improvement of risk-management staffing, protocols, and systems at certain firms has raised the bar for the sector as a whole, in our view.
  • Manager trading ability and understanding of the particular risks of short-selling—and how they might be mitigated—remains mixed.

In what is a continuing point of focus for us, we note that managers are mostly showing good awareness of the credit risks inherent in shorting, fund custody, and prime brokerage arrangements. However, these continue to be addressed only slowly, and not by all.

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