Alternative Investments in a Rising Rate Environment

[fred495]

At this time, I just don't see any good reason to hold most highly recommended and highly rated intermediate core/core plus bond funds with their low SEC dividend yield, now usually in the 1 - 2% range. An exception are some multisector bond funds like PIMIX, RCTIX and TSIIX, for example, that may eke out total returns greater than their SEC yield.

As a retired and somewhat conservative investor, I have been looking for other low volatility options that may offer more competitive total returns in the current low, but seemingly rising, interest rate environment. I have come across several promising alternative funds such as ARBIX, HMEZX, TMSRX, DRSK and JHQAX.

I am in the process of evaluating these funds and would appreciate your comments, opinions and/or suggestions.

Thanks,

Fred

[Norbert]

Fred,

I've dabbled in various esoteric funds like these over the years. These included long-short, market-neutral, and a tactical fund of funds. Each time the funds I bought had very nice, albeit short records. These included Hussman's fund, some AQR funds, the Vanguard low volatility fund, and Pimco's PAUIX (Arnott).

The sad fact is that NONE of these investments worked out. I went from cautious optimism to disappointment every time.

My take is that many such funds get launched. Some work for a while, some better than others. We spot those that have worked for a while; and dismiss the rest. Maybe the managers were lucky; or maybe the market conditions helped; or maybe their idea got arbitraged away.

Having said that, I do see the problem: like stocks, vanilla bonds are overpriced. Rates can seemingly only go up. What's to be done?

It's true that the multi-sector bond funds you cite are attractive. Pimco knows how to hedge against rising rates.

The merger arbitrage fund you cite has a great record. Can it be maintained? I doubt it, but maybe.

DRSK holds 90% investment grade bonds, while taking equity exposure using calls. I fail to see how this vehicle will address your rate concern.

The convertibles arbitrage fund is a black box for me. I'm clueless.

TMSRX is perhaps the most interesting. I think it's a go anywhere fund of funds. Right now it's juicing its returns with 15% in global growth stocks. It takes a lot of exposure to a bag of other funds, including unconstrained bonds. It might do OK; or maybe it will start to fail like Arnott's fund did. Time will tell.

Well, those are my thoughts. If you combine my brilliant insight with a NYC subway token, you can take a ride to Brooklyn.

N.

[FD1000]

Fred: An exception are some multisector bond funds like PIMIX, RCTIX and TSIIX, for example, that may eke out total returns greater than their SEC yield.

FD: the above are good options, but their average already lag my funds by 1% YTD ;-)
You already know what I hold

ARBIX-I posted months ago it's a good fund, you can hold.
TMSRX-another fund with good risk/reward and a good sub for VWIAX.
HMEZX-another good arbitrage but ARBIX has a better risk/reward. You don't need 2 of them.
DRSK and JHQAX: just buy instead some stock ETF, maybe at 20% and use simple indexes such as IWM,EEM,SCHD.  Another option use PRWCX instead for the whole 20%, Yes I know about VLAIX but in these markets a flexible manager is very useful. PRWCX beat DRSK,JHQAX,VLAIX by a nice margin for 1-3-6 months.

I don't know what do you want to achieve but I think PIMIX, RCTIX, TSIIX, ARBIX and TMSRX may make you 6+% with low SD, is this enough?

Remember KISS.  Simple 5 funds portfolio and switch when you see a better fund.  I have seen you doing it for years.
Good luck.

[fred495]

chang once said on another forum: "I don't really need a lot more money - but I certainly don't want to lose a lot. I need to remind myself to err on the side of caution."

It's in that spirit that I recently started looking at options-based strategies, particularly at a time of very elevated equity valuations, a raging pandemic, high unemployment and very high public debt levels.

Hence, the question became: How do I stay invested in the equity market but mitigate risk? Traditionally one would de-risk once portfolio with investment grade fixed income instruments, but today, with very low and seemingly rising interest rates, that is no longer quite as risk-free a strategy as in the past. And, of course, every investor needs to evaluate their own risk tolerance with respect to their desired return.

After doing some research, I came across JHQAX, a fund that has successfully employed an options strategy for the past seven years. M*'s last fund analysis report says that:

"Attractive fees, a transparent and consistent process, and an experienced manager elevate JPMorgan Hedged Equity ahead of its peers. The strategy maintains a Morningstar Analyst Rating of Silver for its cheapest share classes."

The fund has a standard deviation of 7.94%, a Sortino ratio of 1.41, and a 5-year total return of 10.3%.

At this stage of my life, where a good night's sleep is a high priority, an options based fund like JHQAX for a portion of my portfolio may fit my personal risk/reward parameters better than a balanced fund. Due to high debt levels, inflation may be around the corner and in an increasing interest rate environment, the fixed income part of a conventional balanced fund may be a drag on its total return in 2021 and beyond.

Of the other alternative funds I listed, ARBIX and TMSRX also look like promising candidates for my personal portfolio. I am currently "test driving" them along with JHQAX in my 2021 Challenge Portfolio over at M*.

Thanks, again, Norbert and FD for your helpful and very informative comments. Much appreciated.

Fred

P.S. I don't have access to PRWCX, it is closed to new investors. But, it also has a much higher standard deviation compared to JHQAX, 12.54% vs. 7.94%, respectively. And, during the market crash in March, PRWCX lost 9.3% while JHQAX only lost 1.4%.

[FD1000]

Fred: And, during the market crash in March, PRWCX lost 9.3% while JHQAX only lost 1.4%.

You obviously looked at PV which is MONTHLY numbers. JHQAX lost almost 19% and PRWCX almost 27% peak to trough.

If you look for these kinds of funds then HSFAX but also SVARX. See 1 year (chart).  In 03/2020 the other lost less than 2%.

SVARX is a fund of other bond OEFs, and it does what I do.  You can just pay the guy to do it for you...top 10 look familiar to me(see attachment).

And if you are worry just about losing and not making I can solve it too.  Instead of 100% PRWCX I can use 70/30 PRWCX/TLT  VS JHQAX and get similar SD much higher performance (link)

It looks like JHQAX has been doing it for years already, and it has 1.5 billion, so it must be doing something right.

Attachments:

[Norbert]

fred495

JHQAX roughly tracks Wellesley since inception. The two funds have nearly identical Sharpe and Sortino numbers based on PV's monthly stats.

JHQAX depends on the managers' stock picking ability. If I understand correctly, to make money they have to beat their S&P 500 hedge. (The hedge is always in place; there's no market timing.)

The risk going forward is that they are long the wrong stocks. (Again, I know of no other long-short fund that has succeeded medium- to long-term.)

Wellesley risks mediocre or negative returns because their heavy exposure to IG corporates may not work in a rising rate environment. However, I do like its transparency. It's not a black box.

FD's idea to use TLT to hedge equity exposure definitely backtests well. The future may or may not resemble the backtest, for obvious reasons.

I fully grasp the objective of capital preservation. Personally, I lean towards tight control on the spending side; only doing discretionary spending with my profits. (Happily, the profits have been high recently.)

One very conservative approach for those who have reached their capital target, would be to put a lot of money in ST high-quality bonds, thereby limiting portfolio level volatility. Given the present valuations of all asset classes combined with the looming political risk, I think it's a reasonable strategy; ring the cash register and wait for a better entry point.

Thanks for bringing JHQAX to my attention.

N.

[fred495]

FD said: "SVARX is a fund of other bond OEFs, and it does what I do. You can just pay the guy to do it for you...top 10 look familiar to me(see attachment)."

Thanks, FD, for your suggestion. Will check it out.

Quickly looking at the prospectus of SVARX, it states that: "The Fund invests in a diversified portfolio of primarily income-producing fixed income securities. The sub-adviser does not select individual bonds or other fixed income securities but instead, invests the Fund’s assets in open-end investment companies (“mutual funds”) and exchange-traded funds (“ETFs”) that each invest primarily in fixed rate or floating rate fixed income securities."

The ER may be high for a fund of funds, but the results seem to compensate for it:

3-year total return = 10.4%

5-year total return = 11.4%

Standard deviation = 5.36%

Sortino Ratio = 4.95

Fred

[chang]

Jan 16, 2021 5:53:14 GMT Norbert said:

fred495

JHQAX roughly tracks Wellesley since inception. The two funds have nearly identical Sharpe and Sortino numbers based on PV's monthly stats.

JHQAX depends on the managers' stock picking ability. If I understand correctly, to make money they have to beat their S&P 500 hedge. (The hedge is always in place; there's no market timing.)

The risk going forward is that they are long the wrong stocks. (Again, I know of no other long-short fund that has succeeded medium- to long-term.)

Wellesley risks mediocre or negative returns because their heavy exposure to IG corporates may not work in a rising rate environment. However, I do like its transparency. It's not a black box.

See the chart here. What is this fund's advantage over Wellesley? I don't think "beating the S&P500" is a particularly attractive strategic objective (think Bill Miller).

Norbert : "Wellesley risks mediocre or negative returns because their heavy exposure to IG corporates may not work in a rising rate environment." True, but historically the fund has done pretty OK: see chart here.

[fred495]

chang asks: "What is this fund's advantage over Wellesley?"


I prefer looking at the numbers, and JHQAX has clearly produced better total returns with a similar risk profile over the past five years:

JHQAX-----1 year = 13.1%-----3 years = 8.0%-----5 years = 10.6%

VWINX-----1 year = 7.6%------3 years = 6.9%-----5 years = 8.4%

I also quite agree with Norbert's observation that Wellesley, with approximately 60% to 65% of its assets allocated to bonds, "risks mediocre or negative returns because their heavy exposure to IG corporates may not work in a rising rate environment."

As I said before, at a time of very elevated equity valuations, a raging pandemic, high unemployment and very high public debt levels, the question for me is: How do I stay invested in the equity market but mitigate risk? Not being a "buy and hold" investor, JHQAX, with its successful seven year history, deserves my serious consideration at this time.

While, ideally, I also prefer transparency over a black box, I recall making very good money over many years with two funds I used to own, PCI and PIMIX, neither one of which had a great reputation for transparency.

Fred

[chang]

Jan 18, 2021 4:31:01 GMT fred495 said:

chang asks: "What is this fund's advantage over Wellesley?"


I prefer looking at the numbers, and JHQAX has clearly produced better total returns with a similar risk profile over the past five years:

JHQAX-----1 year = 13.1%-----3 years = 8.0%-----5 years = 10.6%

VWINX-----1 year = 7.6%------3 years = 6.9%-----5 years = 8.4%

I look at it a different way. See the 5yr chart here. Notice that JHQAX -- which is ahead of VWIAX every step of the way -- loses its lead and drops to touch (or nearly touch) the chart of VWIAX four times. That tells me that JHQAX is more volatile but not delivering a long-term excess return over Wellesley. It is a hint that if I bought JHQAX at one of the tops, the chart would look different. And indeed it does, see HERE. From 9/28/18 to date, Wellesley leads all the way.

I am not passing any judgment whatsoever on the fund; and of course I am cherry picking the dates -- to illustrate how TR charts can be misleading. An investor who bought both funds about 2-1/2 years ago would not find much reason to be enthusiastic about JHQAX.

It is for this reason that I always use rolling return charts when comparing funds. And HERE is the 3yr rolling return chart. IMO such a chart provides much more insight than a TR chart.

[Norbert]

fred495

My concern is with the long-short concept itself. While it's true that JHQAX has a decent, albeit erratic, record, I think it's very difficult to consistently outperform the market.

Sure, maybe it will succeed. Or, maybe it had a lucky streak capturing alpha by going long large-cap growth and shorting the S&P 500. They've been long FAANG for many years. Definitely a great call, but very challenging to repeat and maintain.

Again, I do grasp your concerns. I just doubt the existence of easy answers in the mutual fund space. Central banks have made QE a habit; and now all asset classes are pricey.

I do think that good Fixed Income traders like Pimco's Ivascyn have a better chance of delivering decent low volatility returns going forward, than the more gimmicky long-short equity, merger arbitrage, convertibles arbitrage, and other concepts.

Just an opinion.

N

[fred495]

I hear you, chang, and appreciate your detailed analysis of the past performance of JHQAX vs. VWINX.

However, looking forward, I agree with Norbert's previous observation that VWINX, with approximately 60% to 65% of its assets allocated to bonds, "risks mediocre or negative returns because their heavy exposure to IG corporates may not work in a rising rate environment."

I have not made a buy decision regarding JHQAX at this time, but if I decide to make a purchase and the fund underperforms significantly at some point, I have no hesitation pressing the sell button. I am not a "buy and hold" type of investor, especially during these very difficult market conditions.

Thanks, again, and good luck,

Fred

[fred495]

Jan 18, 2021 9:00:32 GMT Norbert said:

fred495

My concern is with the long-short concept itself. While it's true that JHQAX has a decent, albeit erratic, record, I think it's very difficult to consistently outperform the market.

Sure, maybe it will succeed. Or, maybe it had a lucky streak capturing alpha by going long large-cap growth and shorting the S&P 500. They've been long FAANG for many years. Definitely a great call, but very challenging to repeat and maintain.

Again, I do grasp your concerns. I just doubt the existence of easy answers in the mutual fund space. Central banks have made QE a habit; and now all asset classes are pricey.

I do think that good Fixed Income traders like Pimco's Ivascyn have a better chance of delivering decent low volatility returns going forward, than the more gimmicky long-short equity, merger arbitrage, convertibles arbitrage, and other concepts.

Just an opinion.

N

Hi Norbert,

I appreciate hearing your well considered opinion. Of course, I am not looking for easy answers, just checking out some low volatility options in the alternative fund space during these quite uncertain times when, as you say, "all asset classes are pricey".

As I said to chang, "if I decide to make a purchase and the fund underperforms significantly at some point, I have no hesitation pressing the sell button. I am not a "buy and hold" type of investor, especially during these very difficult market conditions."

In terms of PIMCO's Ivascyn, I was a long time holder of PCI and PIMIX until the March crash when the performance of both funds was extremely disappointing. Luckily, I sold both funds at the beginning of the crash without incurring significant losses. Frankly, at this point, I am not as optimistic as you are about Ivascyn's ability to make good on "delivering decent low volatility returns going forward", especially with the huge AUM of a fund like PIMIX.

Thanks and good luck,

Fred

[fred495]

I have been looking at Highland Capital Management with respect to their NexPoint Merger Arbitrage fund (HMEZX). In the process, I came across an article in the Wall Street Journal from October 16, 2019 that indicated that the firm filed for bankruptcy.

HMEZX has a very good record, but I was curious why the fund had only attracted $68 million in assets since it opened in September 2016. The answer may be found in this article:

"Highland Capital Management LP, once a giant in high-yield debt markets, filed for bankruptcy protection Wednesday as investors and former employees seek more than $200 million from the firm for alleged improprieties.

The Dallas-based firm founded by Jim Dondero helped pioneer trading of corporate loans rated below investment-grade and managed about $39 billion in 2007, but it took heavy losses during the financial crisis and has been embroiled in lawsuits ever since. The company had been trying in recent weeks to settle some of the litigation it faces, warning its adversaries that it would seek bankruptcy protection if they didn’t compromise, people familiar with the matter said.

Highland entered chapter 11 in U.S. Bankruptcy Court in Wilmington, Del., listing as its largest debt a disputed $189 million claim from investors in Highland Crusader Fund, a hedge fund that has been in liquidation since the financial crisis. The second-largest creditor is Patrick Daugherty, a former Highland portfolio-manager who has been in personal and legal conflict with Mr. Dondero since 2012 and has an $11.7 million claim against Highland, according to its bankruptcy filing.

A group of investors in Crusader sued Highland in 2016 in Delaware Chancery Court, demanding Highland be fired as manager for delaying the fund’s liquidation and claiming that Highland wrongfully paid itself $30 million. The group subsequently won an arbitration award that Highland has yet to pay, court documents show.

In a statement, Highland said the bankruptcy filing was made “in consideration of its liquidity profile” and stems from a potential judgment in favor of a committee of Crusader Fund investors."

I don't know the current status of of the bankruptcy filing, but, needless to say, I am no longer interested in HMEZX as a potential investment opportunity.

If anybody has more up to date information regarding the fund advisor's bankruptcy status, I would appreciate hearing from you.

But, buyer beware.

Fred