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5 Alternative Mutual Funds To Dodge Volatility In 2016

U.S. stock markets have been volatile for a pretty long time. Market volatility can make anyone feel anxious. It threatens the one thing that everybody holds dear – their money. To weather such market swings and book in profits, alternative mutual funds are the best available choice. Their potential to hedge risks, provide unwavering returns and diversify portfolio helps to stand out from other mutual fund classes, particularly in difficult times. Up-and-Down Markets Since June 30, 2015, concerns regarding Grexit have made the markets volatile. Later, from August 24 to August 27, 2015, the Chinese stock market crash unleashed a downward spiral. Add to it the continuous rout in oil prices, uncertainty about the Fed rate hike and selloff in bank stocks and you know why the U.S. markets have been so unstable. The CBOE Volatility Index (VIX) has been proof enough. VIX is “a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices.” VIX being a fear-gauge index moves contrary to market trends. In the first week of January the index gained 48.33%, while in the second week it gained a meager 0.04%. On the other hand, the index declined 17.32% and 9.58% during the last two weeks, respectively. Come February, the index recorded gains of 15.74% and 8.64%, respectively, in the first two weeks, while in the third week it fell 19.17%. This shows that investor sentiment is constantly fluctuating and the stock market is subject to gyrations. Meanwhile, the VIX settled at 20.72 on Wednesday. Any reading above 20 indicates high volatility in the markets. How to Play This Volatility? The best way to navigate market volatility is by investing in alternative mutual funds, which will not only minimize risk but will also provide stable returns. These types of funds are available to investors of all income levels and provide that extra edge brought by diversity. These funds mostly include market-neutral funds, long/short equity funds and trading-leveraged equity funds. Let us now discuss these three types of funds in some details. Market-Neutral Mutual Funds Market-neutral funds aim to adopt a precision approach by shorting 50% of their assets and holding 50% long. This approach seeks to identify pairs of assets whose price movements are related. The fund goes long on the outperforming asset and shorts the underperformer. Say, for example, you take a $1 million long position in Pfizer and a $1 million short position in Wyeth. Both are large pharmaceutical companies. Now, if pharmaceutical stocks fall, you will lose because of your long position in Pfizer but will gain because of the short position in Wyeth. A market-neutral fund is designed to provide stable returns at relatively lower levels of risk regardless of market direction. This is particularly relevant in today’s highly volatile scenario when the objective is to protect the capital invested. Long/Short Mutual Funds Equity long/short funds seek to gain from both winning and losing stocks, irrespective of the current market scenario. These funds use conventional methods to identify stocks that are either undervalued or overvalued. It profits from shorting the overvalued stocks and by buying the undervalued stocks. Weights are subject to change and are dependent on the management’s view regarding the market. For example: Say an investor buys a long/short mutual fund for $100, then the fund manager will invest it in assets that are expected to do well. The manager shorts $30 in stocks that are believed to be overvalued. In the process, he receives $30 in cash. He will now use the $30 to buy more assets with an upside potential. So, now he has a total of $130 invested in long positions and $30 in short positions. This type of long/short fund is called a 130/30 mutual fund. Trading-Leveraged Equity Funds Leveraged funds use borrowed money to increase returns in a short spell of time. These funds generally strive to return a certain multiple of the short-term returns of an equity index. For example, a 2X S&P 500 fund aims to generate twice the returns that the S&P 500 manages to achieve. Leveraged funds are primarily marked “ultra”, “bull” or “2X”. Leveraged funds also offer benefits such as diversification. These funds invest in a diversified portfolio of assets which minimize risk, while escalating returns. In addition to this, investors enjoy the benefits of “dollar cost averaging,” where a young investor depositing $10,000 in these funds reaps the same benefits a high net worth individual receives, say by depositing $50,000,000. These funds also enjoy tax deductions. 5 Alternative Mutual Funds to Invest In The investment community is a dynamic one where new products will come into play and make the most of the stock markets. In times of market volatility, alternative mutual funds are such new product classes that are equipped to protect investors’ portfolio and provide steady returns. Here we have selected five such alternative mutual funds that boast a Zacks Mutual Fund Rank #1 (Strong Buy) or #2 (Buy), have positive 3-year and 5-year annualized returns and carry a low expense ratio. Calamos Market Neutral Income A (MUTF: CVSIX ) seeks high current income. CVSIX invests mainly in convertible securities and employs short selling to enhance income and hedge against market risk. The fund’s 3-year and 5-year annualized returns are 1.9% and 2.7%, respectively. Annual expense ratio of 1.11% is lower than the category average of 1.7%. CVSIX has a Zacks Mutual Fund Rank #1 and has a minimum initial investment of $2,500. Gateway A (MUTF: GATEX ) seeks to capture most of the higher returns associated with equity market investments, while exposing investors to significantly less risk than other equity investments. The fund’s 3-year and 5-year annualized returns are 3% and 3.5%, respectively. Annual expense ratio of 0.94% is lower than the category average of 1.82%. GATEX has a Zacks Mutual Fund Rank #1 and a minimum initial investment of $2,500. Diamond Hill Long-Short A (MUTF: DIAMX ) seeks to provide long-term capital appreciation. DIAMX invests its assets in U.S. equity securities of any size capitalization that are undervalued and sells short equity securities of any size capitalization that are overvalued. The fund’s 3-year and 5-year annualized returns are 5.4% and 6.3%, respectively. Annual expense ratio of 1.4% is lower than the category average of 1.82%. DIAMX has a Zacks Mutual Fund Rank #1 and a minimum initial investment of $2,500. Aberdeen Equity Long-Short A (MUTF: MLSAX ) seeks long-term capital appreciation with a total return greater than the S&P 500 Index. MLSAX invests a large portion of its assets in long and short positions in equity securities of publicly traded companies in the U.S. The fund’s 3-year and 5-year annualized returns are both 0.1. Annual expense ratio of 1.56% is lower than the category average of 1.82%. MLSAX has a Zacks Mutual Fund Rank #2 and a minimum initial investment of $1,000. ProFundsUltraSector Health Care Investor (MUTF: HCPIX ) seeks daily investment results, before fees and expenses that correspond to one and one-half times the daily performance of the Dow Jones U.S. Health CareSM Index. The fund’s 3-year and 5-year annualized returns are 22.9% and 23.9%, respectively. Annual expense ratio of 1.61% is lower than the category average of 1.99%. HCPIX has a Zacks Mutual Fund Rank #2 and a minimum initial investment of $15,000. A higher minimum investment helps the fund manager to control cash flows, which eventually helps management of assets on a regular basis. Original Post

Best And Worst Of January: Nontraditional Bond Funds

Nontraditional bond mutual funds and ETFs had a tough month in January, losing 1.13% on average. This extended the category’s one-year losses through January 31 to -2.57%, consisting of -2.76% alpha and a -0.47 beta, relative to the Barclays US Aggregate Bond Total Return USD Index. Mutual funds and ETFs in the category averaged a -0.66 Sharpe ratio for the year ending January 31, with volatility of 3.53%. The nontraditional bond fund category is a mixed bag of long/short credit funds, non-traditional income funds and unconstrained bond funds. In total, there are 150 funds (only 63 have a track record of 3 years or more) in the category and $129.3 billion of assets. Below is a look at the top and bottom performers for January. Top Performers in January The three best-performing nontraditional bond funds in January were: Navigator Tactical Fixed Income Fund A (MUTF: NTBAX ) BTS Tactical Fixed Income Fund A (MUTF: BTFAX ) Counterpoint Tactical Income Fund A (MUTF: CPATX ) NTBAX was the top-performing nontraditional bond fund in January, posting gains of 2.38%. This was enough to push the fund’s one-year returns through January 31 into the black, at +0.34%. These returns consisted of 0.49% alpha and a 0.76 beta, yielding a Sharpe ratio of 0.09 with standard deviation (volatility) of 3.90%. BTFAX ranked second for the month, with gains of 2.00%. Its one-year returns, however, remained in the red at -0.16%, with -0.02% alpha and a 0.65 beta. BFTAX’s one-year Sharpe ratio stood at -0.04 through January 31, with annualized volatility of 4.15%. Finally, CPATX was the month’s third-best performing nontraditional bond fund in January, with gains of 1.31%. Its 12-month returns through January 31 stood at +2.10%, with 2.09% of alpha and a low 0.15 beta. CPTAX’s Sharpe ratio of 0.60 was by far the best of any fund reviewed this month, and its 3.41% volatility was the lowest. Bottom Performers in January The three worst-performing nontraditional bond funds in January were: Driehaus Select Credit Fund (MUTF: DRSLX ) Putnam Diversified Income Trust A (MUTF: PDINX ) Altegris Fixed Income Long Short Fund A (MUTF: FXDAX ) FXDAX was January’s worst-performing nontraditional bond fund, with its shares falling 5.17% for the month. Through January 31, FXDAX’s one-year returns stood at -9.82%, consisting of -10.50% alpha and a -1.59 beta. This gave the fund a one-year Sharpe ratio of -1.60, with annualized volatility of 6.33%. PDINX, the month’s second-worst performer at -4.83%, also had bad-looking one-year numbers. Its losses of 5.47% were made up of -5.86% alpha and a -2.05 beta, yielding a -0.76 Sharpe ratio and 7.15% volatility. Although it outperformed FXDAX and PDINX in January, DRSLX looked worst of all over the year ending January 31. In those 12 months, the fund lost 11.18%, with -11.97% alpha and a -1.55 beta. Its one-year Sharpe ratio stood at -1.70, and its annual volatility was 6.85%. Even over three- and five-year terms, DRSLX was down an annualized 4.58% and 1.66%, respectively. Past performance does not necessarily predict future results. Jason Seagraves contributed to this article. Note: The MPT benchmark used for the above calculations was the Barclays US Aggregate Bond Total Return USD Index.

Why Stock Market Declines Are Good

James Bullard, the St Louis Fed President, gave an interview today discussing how the stock correction has been good because it has helped to prevent a bubble. He’s inferring that lower prices are bad in the short term and good in the long term. And he’s totally right. I’ll show you why. What happens when the stock market booms is that future returns get pulled into the present. Stock bubbles are dangerous because they pull so much of that future return into the present that they create an abnormal amount of temporal balance sheet instability. I’ve referred to this pricing change as a “price compression” in my book and elsewhere. It’s a fairly simple concept and can help us understand what happens to prices in the short term relative to the long term. In essence, when prices boom in the short term, we pull future returns into the present which often reduces future returns. For instance, imagine a zero coupon bond like a Treasury Bill yielding, for fun, 3%.¹ This Bill will sell at $97.09 and will mature at par plus your 3% in 1 year. Now, imagine that interest rates shoot higher to 6% right after you buy this Bill. The price of your Bill will fall to $94.34 for a 2.83% loss. But that’s just a short-term unrealized loss and not necessarily a realized loss. After all, if you hold the Bill for 1 year you will still get your $100 plus 3% in interest. So, what’s happening here? The price of the Bill has compressed as the market environment changed. Had you purchased another Bill immediately after the price decline you would have earned 5.99% on the second Bill. If you’d doubled down on the first Bill you would have earned an average return of 4.49% on both Bills thereby increasing your average return. The price decline was bad in the short term, but it was good in the long term! In other words, as prices compress positively (think bull market) in the short term they tend to pull future returns into the present thereby lowering future returns, whereas, when prices compress negatively (think, bear market), they push future returns higher. Stocks, while not perfectly analogous to bonds, are essentially coupon paying financial instruments. For instance, rolling mutli-year dividend payments from corporate America have been remarkably stable throughout history.² Now, the problem with the stock market is that the stock market has a very long and relatively imprecise duration³, but by my calculations it’s about 25 years at present. Of course, most people don’t have that kind of patience. But with a bit of clever analysis it’s not hard to build an asset allocation model that reduces that duration by mixing fixed income instruments with stocks making all of this much more precise. And in doing so, you’re essentially capturing that price compression concept in a very intelligent manner by realizing a few things: Price declines are bad in the short term, but good in the long term. Buying dips isn’t just for market timers. It’s for the savvy asset allocator who realizes that price declines will tend to boost future returns. The trick is making sure the duration of your asset allocation matches your overall investment time horizon! The problem with most of today’s stock market asset allocators is that they spend too much time judging a 25 year instrument inside of a short-term time horizon thereby resulting in faulty analysis, excessive activity and all sorts of behavioral biases that reduce future returns. ¹ – I know, I shouldn’t technically call a T-Bill a zero coupon bond, but that’s essentially what it is. And yes, 3% yielding T-Bills were the golden days! ² – See Robert Shiller in ” Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends? ” ³ – I like to think of Corporate America as one aggregate living entity. It doesn’t die. It just evolves over time and shifts a growing pool of profits from one legal entity to another to another (usually changing names or getting gobbled up over time) all adding up to higher profits in the aggregate, in the long run.