Morningstar Advisor - December/January 2010 - 47

Alternatives are viewed as more risky when looked at alone. The word ‘risky’ here means ‘discomforting.’ There are some new things in these strategies. The irony is that when added to a general portfolio these strategies reduce risk. They’re viewed as risky, because they’re different, but their main purpose is to reduce risk. Cliff Asness very difficult to call the market and the economy. The strategies that we implement are meant to try to generate value for investors in a variety of different circumstances. Ultimately, isn’t that what the science of investments ought to be about, to try to understand some of the basic principles that underlie the way markets move and to provide some way for investors to protect their savings and to save for retirement? CA: Paul Samuelson also said that he considers as possible. Albert Einstein pointed out, when he was criticized for the complexities of his theories, that a theory should be as simple as possible, but no simpler. The same holds for mutual fund products. I don’t think it’s advisable to simplify our products so that people can invest in them blindly without understanding what the underlying drivers are. For example, with our global alternatives mutual fund, we invest in stock-index futures, bond and interest-rate futures, commodity futures, and currency forwards. We do it in a diversified, risk-controlled way. We have stop-loss policy. Nevertheless, we’re going to be generating returns in a variety of different markets. When they invest in our product, advisors are going to have to learn more than they would for the typical long-only stock fund or bond fund. The way that we describe the fund is that it is meant to capture the broad-based market exposures of the hedge fund industry, which is certainly more complex than investing in the S&P 500. CA: Nadia, this is why advisors have you, and this is why clients have advisors. In general, I think these strategies are more work, mainly because they’re different. When you drill down, they are more complex, but they’re understandable. There’s not a giant tensor calculus at the base that a client could never understand. There are just more moving parts, and some moving parts they haven’t seen before. alone. The word “risky” here means “discomforting.” There are some new things in these strategies. The irony is that when added to a general portfolio, and not viewed alone, these strategies reduce risk. They’re viewed as risky, because they’re different, but their main purpose is to reduce risk. Finally, if the whole world were comfortable with these strategies and bought the story, the spreads would go way down and the opportunity would go away. If you do something differently than the rest of the world, and if you’re someone who does that in the first 10 years, you get a lot of benefit from that. If you’re someone who does it 20 years later, when everyone knows about it, a lot of the benefit is gone. Andy and I might live in a world where we provide a tremendous amount of value for 10 or 20 years, and then have to think of something else that other people aren’t thinking about. I don’t want to brag too much, but the very fact that people aren’t super comfortable with these strategies is part of the reason the opportunity exists for those who are willing to put in the work. K Nadia Papagiannis, CFA, is an alternative investments strategist with Morningstar. market-timing a sin, and after years of study, he’s determined the proper course is to sin a little (laughter). I think what he means by that is very akin to what I’m saying; there are extremes, there are times where a strategy is so depressed or so crowded that you want to think about changing allocation. But I think those are the 2% tails on each end. If you ignore them, I still think you’re fine long term. It’s just an opportunity. If you do try to time it, you are committing a little bit of a sin, so you should think about it pretty hard. Know What’s Inside NP: A lot of advisors might be wary of alternative strategies because they perceive them as riskier investments that require a lot more research than a stock and bond strategy. But it sounds like you’re saying that they’re not any more risky. AL: I know that advisors like to think in terms of volatility, and for the most part, when we develop our mutual fund products, we keep that in mind and try to keep the strategy as simple There’s some piece of irony here, too. Alternatives are viewed as more risky when looked at MorningstarAdvisor.com 47

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Morningstar Advisor - December/January 2010

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