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Why Aren’t Liquid Alts More Popular in 401ks?

They should be an effective solution to capital market confusion

Alternatives can make a splash in retirement plans.Alternatives can make a splash in retirement plans.

In this market, of all markets, alternative investments and non-correlated assets should be more popular in 401(k)s.

“I’ve been in the 401(k) and retirement plan business for 30 years, and these are the most challenging capital markets I’ve ever seen,” says Jim Pupillo, managing director with the Scottsdale, Arizona office of RIA powerhouse HighTower.

Pupillo is quick to emphasize they’re not the worst markets he’s experienced, only the most challenging, and he’s not alone. Skyrocketing stock market volatility, combined with the end of a 30-year bond bull market makes “finding sources of return at reasonable valuations” increasing difficult, he explains.

“It’s not a question of if interest rates will go up, but when,” he quips. “History doesn’t necessarily repeat itself, but it rhymes, and we all need sources of return.”

Other reasons for capital market angst include:

  • The U.S. Presidential election and the potential for a Black Swan event
  • Uncertainty surrounding Fed action on interest rates
  • Growing questions about the general business environment, among them the fact that earnings are down five straight quarters         
  • Wall Street titans—from Gross and Gundlach to Soros—are bearish

It should all add up to alternative asset classes as a no-brainer. So why aren’t they?

Part of the problem has to do with perception, especially in the wake of 2008.

“Those supposedly non-correlated assets sure were correlated in the economic downturn,” one broker-dealer executive recently remarked.

Indeed, critics argue managed futures were about the only product to perform to expectations during the worst of the crisis and its aftermath, acting as a countercyclical hedge to blunt the impact of a near-complete collapse.

Clifford Stanton isn’t buying it. The chief investment officer of 361 Capital, a boutique asset manager specializing in alternative mutual funds, says they didn’t meet expectations because the expectations were wrong.

Far from plain vanilla offerings, they can provide many different sources of alpha, but they’re strategy-dependent,” he explains. “It really depends on the risk exposure underlying the particular strategy. Alternatives appear to be a heterogeneous space, but the devil is in the details.”

For 401(k) advisors and their clients, the retirement bucket is often the largest–and most critical–portion of a client’s portfolio. As clients approach retirement, sequence-of-return risk rises. Alternatives, and liquid alternatives in particular, limit volatility within the portfolio, stabilize sequence of returns and narrow possible outcomes to help advisors and participants better plan.

“When the market was down over 50 percent, long/short equity was only down in the low 20 percent,” Stanton adds. “It’s a failure on the educational front. What participants need to realize is that it’s not just about losing monetary resources, it’s also about losing time.”

For these reasons, Denver, Colorado-based 361 Capital has a laser like focus on both managed futures and long/short equity. It employs both in-house strategies, and those that are sub-advised.

For the latter, it’s teamed with Analytic Investors out of Los Angeles, a firm that, according to Stanton, is “a pioneer in researching the low-volatility environment, or the phenomenon where taking on more risk is not rewarded with more return, at least in the equity space. What to do about it is a differentiating factor for us.”

The firm has four strategies; two that are counter-trend and employ managed futures, and two with Analytic Investors that employ a long/short thesis. They are:

Counter-Trend Managed Futures Strategies

  • 361 Managed Futures Strategy Fund (AMFZX) – inception date: 12/20/2011
  • 361 Global Counter-Trend Fund (AGFZX) – inception date: 2/12/2014

 Long/Short Equity Strategies, sub-advised by Analytic Investors

  • 361 Global Long/Short Equity Fund (AGAZX) – inception date: 1/6/2014
  • 361 Domestic Long/Short Equity Fund (ADMZX) – inception date: 3/31/2016

For his part, Pupillo notes the need for a daily NAV for 401(k) record-keeping, which makes alternative investments in a mutual fund format ideal.

“Plan advisors and sponsors can’t be way out there on the risk scale in 401(k), so alternatives are best used as a hedge,” he says. “We use them as 10 percent to 15 percent of an aggregate allocation to our portfolios to be countercyclical and dampen volatility.”

“The central bank has artificially propped up markets, and now it’s a question of how will it be unwound,” Stanton concludes when asked about recent Fed action and future speculation. “Should we have a lot of confidence they will do it right? No. This is one reason why non-correlated assets are critical, but they need to be in place beforehand.”

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