Swedroe: Alternative Approach To Alts

March 05, 2018

Results

We now have more than four full years of live data for the funds. Using the higher-cost version, QSPIX, allows us to go back to November 2013, and starting in November 2014, we use QSPRX, which has expenses 10 basis points lower. Since inception, the fund has returned 8.5% with volatility of just 6.8%. That’s better than our estimated forward-looking return expectations on both counts.

It is important to understand that expected returns are the mean of a very wide potential distribution of possible returns. Thus, they are not a guarantee of future results.

Expected returns are forward-looking forecasts and are subject to numerous assumptions, risks and uncertainties, which change over time, and actual results may differ materially from those anticipated in an expected return forecast. Expected return forecasts are hypothetical in nature and should not be interpreted as a demonstration of actual performance results or be interpreted as a target return.

One negative of the fund is its relative tax inefficiency (due to high turnover and use of derivatives), with an effective tax rate of about 37% since inception. Thus, there should be a strong preference for holding the fund in tax-advantaged accounts.

A New, More-Tax-Efficient, Alternative Fund

AQR has announced it is launching a new and more tax efficient version of its alternative strategy, the Alternative Risk Premia Fund (QRPRX).* The fund has an expense ratio of 1.3%. It uses the same multistyle factor approach as QSPRX, though it adds two new factors, trend (time-series momentum) and risk variance (selling volatility insurance). That’s a total of six factors to which investors will have exposure in one fund.

Another difference between QSPRX and QRPRX is that the latter fund will not have exposure to the factors in the asset class of commodities (due to capacity constraints caused by regulatory rules). It will provide exposure to the value, momentum and trend factors across stocks, bonds and currencies; the carry factor in bonds and currencies; and the risk variance factor in stocks. Exposures are gained through the use of stocks, futures, swaps, currency forwards and options.

Diversification

The correlations of the factors that QRPRX seeks to capture are low to negative, not only relative to each other, but to stocks and bonds as well. Thus, the fund’s returns should be uncorrelated with other portfolio assets.

Specifically, the targeted allocations to each factor are:

  • Risk variance: 3%
  • Trend: 12%
  • Defensive: 15%
  • Carry: 10%
  • Momentum: 28%
  • Value: 32%

By asset class, the targeted allocations are as follows: currencies: 24%; bonds: 23%; stocks and industries: 30%; and equity indices: 23%.

Tax Efficiency

QRPRX will focus on tax-aware strategies. For example, tax losses realized by the fund’s long/short equity sleeve can be used to offset gains in other sleeves. The long/short nature of the fund means there are more opportunities to harvest losses. Also, gains will tend to be more long term, with losses being more short term.

Eliminating commodities from the fund also improves tax efficiency. The result is that the expected tax rate, at about 10-15%, is anticipated to be much lower than the 37% experienced by QSPRX. Thus, the fund would be much more suitable than QSPRX to a taxable account.

 

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