Morningstar Magazine - February/March 2018 - 37

EXHIBIT 5

Morningstar Medalists With High Correlation, Low Volatility
Fund Name

Morningstar
Relative
Morningstar Category Analyst Rating Correlation Volatility %

Litman Gregory Masters Alt Strats Instl MASFX

Multialternative

0.90

Principal Global Multi-Strategy Instl PSMIX

Multialternative

0.79

Merger Investor MERFX

Market Neutral

0.77

AllianzGI Structured Return Instl AZIIX

Option Writing

0.54

Source: Morningstar Direct. Medalist data as of 12/31/2017. Correlation and relative volatility data as of 07/31/2017.

EXHIBIT 6

Morningstar Medalists With Negative Correlation, High Volatility
Fund Name

Morningstar
Relative
Morningstar Category Analyst Rating Correlation Volatility %

AQR Managed Futures Strategy N AQMNX

Managed Futures

-0.33

Natixis ASG Managed Futures Strategy Y ASFYX

Managed Futures

-0.06

106

AQR Managed Futures Strategy HV I QMHIX

Managed Futures

-0.32

145

Abbey Capital Futures Strategy I ABYIX

Managed Futures

-0.22

Source: Morningstar Direct. Medalist data as of 12/31/2017. Correlation and relative volatility data as of 07/31/2017.

One of the funds is a Morningstar Medalist:
AC Alternatives Market Neutral ACVVX
had a slightly negative correlation to stocks and
bonds over the three-year period, and its
pair-trading strategy has resulted in a low volatility
profile. It earns a Bronze rating.
Similar to other lower-volatility alternative funds,
investors may see these strategies as an option
to replace some fixed-income exposure. Unlike the
funds in the top left corner of the alternatives
style box, these strategies' negative correlations to
equities show they had more of a defensive
posture when equities sold off.
Each of the funds had a negative downside
capture over the trailing three years, which means
they generated gains while stocks were down,
on average, over that period. That doesn't mean
the funds were riskless over that period, of
course. It simply means stock market risk was not
the main risk driving returns. As stocks are
likely the riskiest part of investor portfolios,
identifying alternatives that court risks other than
stock market beta is ideal.
Set Expectations

leverage than strategies that rely on physical
securities. Essentially, they bet that winners
will keep winning and losers will keep losing. The
potential to benefit from assets falling in value,
like oil in late 2014 or stocks during the financial
crisis, contributes to the strategy's low and
sometimes negative correlation to global stocks.
Even though managed-futures funds may have
a negative correlation to global equities,
trend-following has shown it can still generate
positive long-term returns, which investors
should expect from an alternatives strategy
regardless of its correlation to equities. To be sure,
that doesn't make them a replacement for
high-quality bonds, which have similar
diversification characteristics and much lower
volatility. For investors comfortable taking on
equitylike risk in their alternative fund, managed
futures could be an attractive option. Other
funds with a negative correlation to equities may
be positioned to only gain when stock markets
fall, which would be less useful over the long term
given that equities generally rise over long

time periods. There are four funds that fall
into this style box that are Morningstar Medalists
( E X H I B IT 6 ).
Alternative Funds With Negative Correlation
and Low Relative Volatility
In the bottom left corner of the alternatives style
box are funds with a negative correlation to
equities and low relative volatility. The further a
fund is plotted toward the bottom of the style box,
the more negatively correlated it is. It's important
to remember that a negative correlation of less
than 0.5 doesn't imply the strategy will always act
in the exact inverse of stocks. It does signal
that the strategy is not dependent on the direction
of stocks to generate returns, though, which can
make it a useful building block for a portfolio.
This section of the style box is the most
sparsely populated:

The examples in this article cover a short
period of time, and the results shouldn't be
expected to hold over every market environment.
Still, we believe the factors that investors
should consider as part of their due-diligence
process when evaluating an alternative strategy
are unlikely to change regardless of whether
the process starts today, tomorrow, or several
years from now. Paying attention to how a strategy
has been correlated to equity markets over time
and in specific market periods, like the volatile
third quarter of 2015, and what kind of volatility it
has exhibited relative to equities, could help
investors better set expectations for alternatives.
As liquid alternative funds continue to develop
track records, we'll be able to examine how these
factors change over different market environments.
For now, investors should still consider these
factors as part of the evaluation process. K
Jason Kephart, CFA, is a senior analyst, alternative
strategies, with Morningstar Research Services.

Market Neutral

Multialternative

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